The Reliability of Management Earnings Forecasts in IPO Prospectuses: A Study of Managers’ Forecasting Preferences
This study investigates the reliability of management earnings forecasts with reference to these two ingredients: verifiability and neutrality. Specifically, we examine the biasedness (or accuracy) of management earnings forecasts and company specific characteristics that can be associated with accuracy. Based on sample of 102 IPO prospectuses published for admission on NYSE Euronext Paris from 2002 to 2010, we found that these forecasts are on average optimistic and two of the five test variables, earnings variability and financial leverage are significant in explaining ex post bias. Acknowledging the possibility that the bias is the result of the managers’ forecasting behavior, we then examine whether managers decide to under-predict, over-predict or forecast accurately for self-serving purposes. Explicitly, we examine the role of financial distress, operating performance, ownership by insiders and the economy state in influencing managers’ forecasting preferences. We find that managers of distressed firms seem to over-predict future earnings. We also find that when managers are given more stock options, they tend to under-predict future earnings. Finally, we conclude that the management earnings forecasts are affected by an intentional bias due to managers’ forecasting preferences.
[1] Ajinkya, B. et Gift M.J. (1984), "Corporate managers’ earnings forecasts and symmetrical adjustments of market expectations", Journal of Accounting Research, 22, pp. 425-444.
[2] Ajinkya B., Bhoraj S., and Sengupta P. (2005), "The association between outside directors, institutional investors and the properties of management earnings forecasts", Journal of Accounting Research, (43) 3, pp. 343-376.
[3] Bamber, L. S. and Cheon, Y. S. (1998) Discretionary management earnings forecast disclosures: antecedents and outcomes associated with forecast venue and forecast specificity choices, Journal of Accounting Research, 36, 167–90.
[4] Barniv R. et al., (2006), "An International Analysis of Historical and Forecast Earnings in Accounting-Based Valuation Models”, Journal of Business Finance & Accounting, pp 1087–1109.
[5] Barua A., (2008), Using the FASB’s Qualitative Characteristics in Earnings Quality Measures, Louisiana State University, 52p.
[6] Bilson C., Heaney R., Powell J.G, et Shi J. (2003), "The Decision to voluntary provide an IPO Prospectus earnings forecast: theoretical implications and empirical evidence", Working Paper, Australian National University.
[7] Boesso G., (2003), How to Assess the Quality of Voluntary Disclosures, Journal of Accounting and Financial Research”, n.1.
[8] Boulton, Thomas, Scott Smart and Chad Zutter, "Earnings Quality and International IPO Underpricing," The Accounting Review, 86, March 2011, 483-505.
[9] Broy G. and Shatt A (2002), "Comment réduire la sous-évaluation lors de l'introduction en bourse?" (with A. Schatt), La Revue des Sciences de Gestion, n° 196.
[10] Brown S. and al., (2005), "Management Forecasts and Litigation Risk”, Working Paper, Emory University, INSEAD, University of British Columbia.
[11] Chan Y. et al. (1996), "Possible Factors of the Accuracy of Prospectuses Earnings Forecasts in Hong Kong", The International Journal of Accounting, 31(3), pp. 381–398.
[12] Chen, C.X., Doogar, R. and Li, L.Y. (2008) "Disaggregation and the quality of management earnings forecasts” Available at SSRN: http://ssrn.com/abstract=1270844
[13] Chen, G., Firth M. and Krishnan, G. (2001), "Earnings forecast errors in IPO prospectuses and their association with initial stock returns", Journal of Multinational Financial Management, vol. 11, pp. 225-240.
[14] Cheng, Qiang and Luo, (2013), Managerial Incentives and Management Forecast Precision Available at SSRN: http://ssrn.com/abstract=2202064
[15] Cheng, T., and Firth, M. (2000). "An empirical analysis of the bias and rationality of profit forecasts published in new issue prospectuses." Journal of Business Finance & Accounting 27(3): 423-446.
[16] Clarkson, P., Dontoh A, Richardson G. et Sefcik S. (1992), "The Voluntary Inclusion of Earnings Forecasts in IPO Prospectuses", Contemporary Accounting Research, vol. 8, pp.601-626.
[17] Clarkson, P.M., (2000), "Auditor Quality and Accuracy of Management Earnings Forecasts”, Contemporary Accounting Research, 17 (4), pp. 595-622.
[18] Clement, M., Frankel R, and Miller J., (2003), "Confirming Management Earnings Forecasts, Earnings Uncertainty, and Stock Returns", Journal of Accounting Research, 41 (4), pp. 653-679.
[19] Choi, J., Myers, L.; Ziebart, D.; and Zang, Y. (2008), "The Effect of Management Earnings Forecasts on the Relationship between Returns and Future Earnings and the Implications for the Continuation of Management’s Quarterly Earnings Guidance”, American Accounting Association (AAA) Annual Meeting. Research Collection School Of Accountancy.
[20] Deaconu A. and al., (2008), "Solutions for Measuring the Quality of the Accounting, Information”, Accounting and Management Information Systems, No. 24.
[21] Dhole S., Mishra S. and Sivaramakrishnan K. (2010), "On the Cross-Sectional Determinants of Bias in Management Earnings Forecasts”, Fourth ISB Accounting Research Conference, Hyderabad, 19-20 December.
[22] Dichev I. et Tang V. (2009), "Earnings volatility and earnings predictability”, Journal of Accounting and Economic, Vol 47, pp 160-181.
[23] El-Rajabi M. and al. (2006), "The accuracy of earnings forecasts disclosed in the prospectuses of newly formed public companies in Jordan”; Managerial Auditing Journal, 21, pp.117- 131.
[24] Fairfield P. and Whisenant S., (2010), Using Fundamental Analysis to Assess Earnings Quality: Evidence from the Center for Financial Research and Analysis, Journal of Accounting, Auditing and finance, Vol 16, pp 273-295.
[25] Firth, M., Gounopoulos, D. et Pulm J. (2013), "IFRS Adoption and Management Earnings Forecasts of Australian IPOs”. Available at SSRN: http://ssrn.com/abstract=2199034
[26] Firth M. (1998), "IPO profit forecasts and their role in signaling firm value and explaining post-listing returns", Applied Financial Economics, 8(1), pp. 23-39.
[27] Gao J.Z & Zhou X.S. (2009), "Information Asymmetry,the Characteristics of Directorate and the Selection of Management Forecast Disclosure- An Empirical Study Based on the Data From 2004-2007 of a Listed Company in China”, Collected Essays on Finance and Economics, 2009-05.
[28] Gong, G., Li, L., & Zhou, L. (2009). Earnings non-synchronicity and voluntary disclosure. Working paper, Pennsylvania State University.
[29] Gounopoulos D. (2004), ‘‘Accuracy of Management Earnings Forecasts in IPO Prospectuses: Evidence from Athens Stock Exchange’’, Working Paper, in Global Finance Association Conference, Las Vegas, USA, 29p.
[30] Hartnett, N. and Romcke, J. (2000), "The predictability of management forecast error: A study of Australian IPO disclosure", Multinational Finance Journal, 4 (1/2), pp.101-132.
[31] Healy, P. and Palepu K., (2001), "Information Asymmetry, Corporate Disclosure, and the Capital Markets: A Review of the Empirical Disclosure Literature", Journal of Accounting and Economics, 31, pp.405-440.
[32] Hirst, D.E., L. Koonce and S. Venkataraman (2007), «How Disaggregation Enhences the Credibility of Management Earnings Forecasts», Journal of Accounting Research, 45(4), 811-837.
[33] Irani, A. (2000), "Determinants of bias in management earnings forecasts", Accounting Enquiries, 10 (1), 33–86.
[34] Jaggi B., Chin c., William. C, Lee L., (2006), "Earnings forecast disclosure regulation and earnings management: evidence from Taiwan IPO firms”, Review of Quantitative Finance and Accounting, 2006, vol. 26, issue 3, pages 275-299.
[35] Jennings, R. (1987), "Unsystematic Security Price Movements, Management Earnings Forecasts, and Revisions in Consensus Analyst Earnings Forecasts,” Journal of Accounting Research, pp. 90-110.
[36] Jeny A.C. and Jeanjean T. (2007), "Levels of voluntary disclosure in IPO prospectuses: an empirical analysis”, Review of Accounting and Finance, 6(2), pages 131-149.
[37] Jog, V., and McConomy B. J., (2003), "Voluntary Disclosure of Management Earnings Forecasts in IPO Prospectuses”, Journal of Business Finance & Accounting, 30 (1/2), pp125-167.
[38] King, R.; Pownall, G.; and Waymire, G. (1990), "Expectations adjustment via timely earnings forecast disclosure: Review, synthesis and suggestions for future research", Journal of Accounting Literature, 9, pp.113-144.
[39] Koch, A. (2002), Financial distress and the credibility of management earnings forecasts. Working Paper, Carnegie Mellon University.
[40] Lee, P., C. Yee and Yee M. (1993), "Prospectus Earnings Forecasts: Evidence and Explanations", Australian Accounting Review, 3, pp. 21–32.
[41] Lev, B. and Penman S. H., (1990), "Voluntary Forecast Disclosure, Nondisclosure, and Stock Prices", Journal of Accounting Research, (28), pp 49-76.
[42] Lonkani, R. and M. Firth (2005). "The accuracy of IPO profit forecasts in Thailand and their relationships with stock market valuation." Accounting and Business Research 35(3).
[43] Miller, G. S., (2002), "Earnings performance and discretionary disclosure", Journal of Accounting Research, 40, pp.173-204.
[44] Mohammady A. (2010), Earnings Quality Constructs and Measures, The Business Review, Cambridge, vol 16.
[45] Norton, Curtis L., Michael A. Diamond, and Donald P. Pagach., (2007). Intermediate Accounting: Financial Reporting and Analysis, second edition, Houghton Mifflin Company, Boston.
[46] Ohlson, J. (1980), "Financial Ratios and the Probabilistic Prediction of Bankruptcy," Journal of Accounting Research, pp. 109-131.
[47] Ota, K. (2011), "Analysts’ awareness of systematic bias in management earnings forecasts”, Applied Financial Economics, 2011, 21, 1317–1330.
[48] Pedwell, K., Warsame, H. and Neu, D. (1994), « The accuracy of Canadian and New-Zealand earnings forecasts: a comparison of voluntary versus compulsory disclosures», Journal of International Accounting Auditing and Taxation, 3 (2), pp. 221-236.
[49] Penman, S. (1980), "An Empirical Investigation of the Voluntary Disclosure of Corporate Earnings Forecasts”, Journal of Accounting Research, 18 (1), pp. 132-160.
[50] Rogers, J. L., and Stocken P., (2005), "Credibility of management forecasts", The Accounting Review, 80, pp1233-1260.
[51] Schatt, A. et T. Roy (2002), "Analyse empirique des écarts de prévisions de bénéfices dans les prospectus d’introduction", Actes du 23ème congrès de l’AFC, Toulouse.
[52] Siougle G.(2007), "Earnings Forecasts Disclosed in SEO Prospectuses: Evidence from an Emerging Market”, Journal of Emerging Market Finance; 6; pp249-267.
[53] Skinner, D. (1994). Why firms voluntarily disclose bad news. Journal of Accounting Research 32 (1): 38–60.
[54] Skinner, D. and Sloan, R. (2002) Earnings surprises, growth expectations, and stock returns or don’t let an earnings torpedo sink your portfolio, Review of Accounting Studies, 7, 289–312.
[55] Yang C.H. and Kao H.S. (2007), "The Association between Management Earnings Forecast Errors and Corporate Governance Structure in IPO Firms”, China Accounting Review, 2007-02.
[56] Waymire, G. (1984), "Additional Evidence on the Information Content of Management Earnings Forecasts”, Journal of Accounting Research, 22, pp. 703-718.
[57] Zhonglan D., Suresh R., and Weining Z., (2009), Implicit/Explicit Incentives and Management Earnings Forecasts, working paper, University of Texas at Dallas, 50 p.
[1] Ajinkya, B. et Gift M.J. (1984), "Corporate managers’ earnings forecasts and symmetrical adjustments of market expectations", Journal of Accounting Research, 22, pp. 425-444.
[2] Ajinkya B., Bhoraj S., and Sengupta P. (2005), "The association between outside directors, institutional investors and the properties of management earnings forecasts", Journal of Accounting Research, (43) 3, pp. 343-376.
[3] Bamber, L. S. and Cheon, Y. S. (1998) Discretionary management earnings forecast disclosures: antecedents and outcomes associated with forecast venue and forecast specificity choices, Journal of Accounting Research, 36, 167–90.
[4] Barniv R. et al., (2006), "An International Analysis of Historical and Forecast Earnings in Accounting-Based Valuation Models”, Journal of Business Finance & Accounting, pp 1087–1109.
[5] Barua A., (2008), Using the FASB’s Qualitative Characteristics in Earnings Quality Measures, Louisiana State University, 52p.
[6] Bilson C., Heaney R., Powell J.G, et Shi J. (2003), "The Decision to voluntary provide an IPO Prospectus earnings forecast: theoretical implications and empirical evidence", Working Paper, Australian National University.
[7] Boesso G., (2003), How to Assess the Quality of Voluntary Disclosures, Journal of Accounting and Financial Research”, n.1.
[8] Boulton, Thomas, Scott Smart and Chad Zutter, "Earnings Quality and International IPO Underpricing," The Accounting Review, 86, March 2011, 483-505.
[9] Broy G. and Shatt A (2002), "Comment réduire la sous-évaluation lors de l'introduction en bourse?" (with A. Schatt), La Revue des Sciences de Gestion, n° 196.
[10] Brown S. and al., (2005), "Management Forecasts and Litigation Risk”, Working Paper, Emory University, INSEAD, University of British Columbia.
[11] Chan Y. et al. (1996), "Possible Factors of the Accuracy of Prospectuses Earnings Forecasts in Hong Kong", The International Journal of Accounting, 31(3), pp. 381–398.
[12] Chen, C.X., Doogar, R. and Li, L.Y. (2008) "Disaggregation and the quality of management earnings forecasts” Available at SSRN: http://ssrn.com/abstract=1270844
[13] Chen, G., Firth M. and Krishnan, G. (2001), "Earnings forecast errors in IPO prospectuses and their association with initial stock returns", Journal of Multinational Financial Management, vol. 11, pp. 225-240.
[14] Cheng, Qiang and Luo, (2013), Managerial Incentives and Management Forecast Precision Available at SSRN: http://ssrn.com/abstract=2202064
[15] Cheng, T., and Firth, M. (2000). "An empirical analysis of the bias and rationality of profit forecasts published in new issue prospectuses." Journal of Business Finance & Accounting 27(3): 423-446.
[16] Clarkson, P., Dontoh A, Richardson G. et Sefcik S. (1992), "The Voluntary Inclusion of Earnings Forecasts in IPO Prospectuses", Contemporary Accounting Research, vol. 8, pp.601-626.
[17] Clarkson, P.M., (2000), "Auditor Quality and Accuracy of Management Earnings Forecasts”, Contemporary Accounting Research, 17 (4), pp. 595-622.
[18] Clement, M., Frankel R, and Miller J., (2003), "Confirming Management Earnings Forecasts, Earnings Uncertainty, and Stock Returns", Journal of Accounting Research, 41 (4), pp. 653-679.
[19] Choi, J., Myers, L.; Ziebart, D.; and Zang, Y. (2008), "The Effect of Management Earnings Forecasts on the Relationship between Returns and Future Earnings and the Implications for the Continuation of Management’s Quarterly Earnings Guidance”, American Accounting Association (AAA) Annual Meeting. Research Collection School Of Accountancy.
[20] Deaconu A. and al., (2008), "Solutions for Measuring the Quality of the Accounting, Information”, Accounting and Management Information Systems, No. 24.
[21] Dhole S., Mishra S. and Sivaramakrishnan K. (2010), "On the Cross-Sectional Determinants of Bias in Management Earnings Forecasts”, Fourth ISB Accounting Research Conference, Hyderabad, 19-20 December.
[22] Dichev I. et Tang V. (2009), "Earnings volatility and earnings predictability”, Journal of Accounting and Economic, Vol 47, pp 160-181.
[23] El-Rajabi M. and al. (2006), "The accuracy of earnings forecasts disclosed in the prospectuses of newly formed public companies in Jordan”; Managerial Auditing Journal, 21, pp.117- 131.
[24] Fairfield P. and Whisenant S., (2010), Using Fundamental Analysis to Assess Earnings Quality: Evidence from the Center for Financial Research and Analysis, Journal of Accounting, Auditing and finance, Vol 16, pp 273-295.
[25] Firth, M., Gounopoulos, D. et Pulm J. (2013), "IFRS Adoption and Management Earnings Forecasts of Australian IPOs”. Available at SSRN: http://ssrn.com/abstract=2199034
[26] Firth M. (1998), "IPO profit forecasts and their role in signaling firm value and explaining post-listing returns", Applied Financial Economics, 8(1), pp. 23-39.
[27] Gao J.Z & Zhou X.S. (2009), "Information Asymmetry,the Characteristics of Directorate and the Selection of Management Forecast Disclosure- An Empirical Study Based on the Data From 2004-2007 of a Listed Company in China”, Collected Essays on Finance and Economics, 2009-05.
[28] Gong, G., Li, L., & Zhou, L. (2009). Earnings non-synchronicity and voluntary disclosure. Working paper, Pennsylvania State University.
[29] Gounopoulos D. (2004), ‘‘Accuracy of Management Earnings Forecasts in IPO Prospectuses: Evidence from Athens Stock Exchange’’, Working Paper, in Global Finance Association Conference, Las Vegas, USA, 29p.
[30] Hartnett, N. and Romcke, J. (2000), "The predictability of management forecast error: A study of Australian IPO disclosure", Multinational Finance Journal, 4 (1/2), pp.101-132.
[31] Healy, P. and Palepu K., (2001), "Information Asymmetry, Corporate Disclosure, and the Capital Markets: A Review of the Empirical Disclosure Literature", Journal of Accounting and Economics, 31, pp.405-440.
[32] Hirst, D.E., L. Koonce and S. Venkataraman (2007), «How Disaggregation Enhences the Credibility of Management Earnings Forecasts», Journal of Accounting Research, 45(4), 811-837.
[33] Irani, A. (2000), "Determinants of bias in management earnings forecasts", Accounting Enquiries, 10 (1), 33–86.
[34] Jaggi B., Chin c., William. C, Lee L., (2006), "Earnings forecast disclosure regulation and earnings management: evidence from Taiwan IPO firms”, Review of Quantitative Finance and Accounting, 2006, vol. 26, issue 3, pages 275-299.
[35] Jennings, R. (1987), "Unsystematic Security Price Movements, Management Earnings Forecasts, and Revisions in Consensus Analyst Earnings Forecasts,” Journal of Accounting Research, pp. 90-110.
[36] Jeny A.C. and Jeanjean T. (2007), "Levels of voluntary disclosure in IPO prospectuses: an empirical analysis”, Review of Accounting and Finance, 6(2), pages 131-149.
[37] Jog, V., and McConomy B. J., (2003), "Voluntary Disclosure of Management Earnings Forecasts in IPO Prospectuses”, Journal of Business Finance & Accounting, 30 (1/2), pp125-167.
[38] King, R.; Pownall, G.; and Waymire, G. (1990), "Expectations adjustment via timely earnings forecast disclosure: Review, synthesis and suggestions for future research", Journal of Accounting Literature, 9, pp.113-144.
[39] Koch, A. (2002), Financial distress and the credibility of management earnings forecasts. Working Paper, Carnegie Mellon University.
[40] Lee, P., C. Yee and Yee M. (1993), "Prospectus Earnings Forecasts: Evidence and Explanations", Australian Accounting Review, 3, pp. 21–32.
[41] Lev, B. and Penman S. H., (1990), "Voluntary Forecast Disclosure, Nondisclosure, and Stock Prices", Journal of Accounting Research, (28), pp 49-76.
[42] Lonkani, R. and M. Firth (2005). "The accuracy of IPO profit forecasts in Thailand and their relationships with stock market valuation." Accounting and Business Research 35(3).
[43] Miller, G. S., (2002), "Earnings performance and discretionary disclosure", Journal of Accounting Research, 40, pp.173-204.
[44] Mohammady A. (2010), Earnings Quality Constructs and Measures, The Business Review, Cambridge, vol 16.
[45] Norton, Curtis L., Michael A. Diamond, and Donald P. Pagach., (2007). Intermediate Accounting: Financial Reporting and Analysis, second edition, Houghton Mifflin Company, Boston.
[46] Ohlson, J. (1980), "Financial Ratios and the Probabilistic Prediction of Bankruptcy," Journal of Accounting Research, pp. 109-131.
[47] Ota, K. (2011), "Analysts’ awareness of systematic bias in management earnings forecasts”, Applied Financial Economics, 2011, 21, 1317–1330.
[48] Pedwell, K., Warsame, H. and Neu, D. (1994), « The accuracy of Canadian and New-Zealand earnings forecasts: a comparison of voluntary versus compulsory disclosures», Journal of International Accounting Auditing and Taxation, 3 (2), pp. 221-236.
[49] Penman, S. (1980), "An Empirical Investigation of the Voluntary Disclosure of Corporate Earnings Forecasts”, Journal of Accounting Research, 18 (1), pp. 132-160.
[50] Rogers, J. L., and Stocken P., (2005), "Credibility of management forecasts", The Accounting Review, 80, pp1233-1260.
[51] Schatt, A. et T. Roy (2002), "Analyse empirique des écarts de prévisions de bénéfices dans les prospectus d’introduction", Actes du 23ème congrès de l’AFC, Toulouse.
[52] Siougle G.(2007), "Earnings Forecasts Disclosed in SEO Prospectuses: Evidence from an Emerging Market”, Journal of Emerging Market Finance; 6; pp249-267.
[53] Skinner, D. (1994). Why firms voluntarily disclose bad news. Journal of Accounting Research 32 (1): 38–60.
[54] Skinner, D. and Sloan, R. (2002) Earnings surprises, growth expectations, and stock returns or don’t let an earnings torpedo sink your portfolio, Review of Accounting Studies, 7, 289–312.
[55] Yang C.H. and Kao H.S. (2007), "The Association between Management Earnings Forecast Errors and Corporate Governance Structure in IPO Firms”, China Accounting Review, 2007-02.
[56] Waymire, G. (1984), "Additional Evidence on the Information Content of Management Earnings Forecasts”, Journal of Accounting Research, 22, pp. 703-718.
[57] Zhonglan D., Suresh R., and Weining Z., (2009), Implicit/Explicit Incentives and Management Earnings Forecasts, working paper, University of Texas at Dallas, 50 p.
@article{"International Journal of Business, Human and Social Sciences:67302", author = "Maha Hammami and Olfa Benouda Sioud", title = "The Reliability of Management Earnings Forecasts in IPO Prospectuses: A Study of Managers’ Forecasting Preferences", abstract = "This study investigates the reliability of management earnings forecasts with reference to these two ingredients: verifiability and neutrality. Specifically, we examine the biasedness (or accuracy) of management earnings forecasts and company specific characteristics that can be associated with accuracy. Based on sample of 102 IPO prospectuses published for admission on NYSE Euronext Paris from 2002 to 2010, we found that these forecasts are on average optimistic and two of the five test variables, earnings variability and financial leverage are significant in explaining ex post bias. Acknowledging the possibility that the bias is the result of the managers’ forecasting behavior, we then examine whether managers decide to under-predict, over-predict or forecast accurately for self-serving purposes. Explicitly, we examine the role of financial distress, operating performance, ownership by insiders and the economy state in influencing managers’ forecasting preferences. We find that managers of distressed firms seem to over-predict future earnings. We also find that when managers are given more stock options, they tend to under-predict future earnings. Finally, we conclude that the management earnings forecasts are affected by an intentional bias due to managers’ forecasting preferences.
", keywords = "Intentional bias, Management earnings forecasts, neutrality, verifiability.", volume = "8", number = "6", pages = "1657-10", }
