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Analysts’ forecast optimism: The effects of managers’ incentives on analysts’ forecasts

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  • Brown, Anna Bergman
  • Lin, Guoyu
  • Zhou, Aner
Abstract
Sell-side analysts are rewarded for forecasting accurately, yet prior literature shows that analysts’ earnings forecasts exhibit an optimistic bias, which is generally attributed to analysts’ compensation structure or a desire to extract private information from managers. Building upon the theoretical model from Beyer (2008), we propose that analysts make decisions about forecasting while considering both optimism and accuracy: analysts forecast optimistically in anticipation of managers’ upward manipulation of earnings in order to meet or beat forecasts. We find that the upward bias in analysts’ earnings forecasts is increasing in the cost of managers missing forecasts (measured using leverage) and the volatility of earnings (using the standard deviation of ROA), and decreasing in the cost of earnings management (measured using Big 4 auditor, a pre- vs. post-Sarbanes Oxley test, and a DID test of larger vs. smaller firms, pre- vs. post-Sarbanes Oxley Section 404 implementation). Further tests suggest that these results are attributable to a lower (higher) incidence of earnings management for Big 4 and post-Sarbanes Oxley firms (firms with higher leverage and more volatile earnings). Our results provide evidence of a rational explanation for analysts’ decision making that considers both forecast optimism and a strategy to forecast accurately.

Suggested Citation

  • Brown, Anna Bergman & Lin, Guoyu & Zhou, Aner, 2022. "Analysts’ forecast optimism: The effects of managers’ incentives on analysts’ forecasts," Journal of Behavioral and Experimental Finance, Elsevier, vol. 35(C).
    • Handle: RePEc:eee:beexfi:v:35:y:2022:i:c:s2214635022000508
    DOI: 10.1016/j.jbef.2022.100708
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    1. Liu, Xingyu & Kok Loang, Ooi, 2023. "Analysts’ forecast optimism and cash holding: Evidence from China," Finance Research Letters, Elsevier, vol. 57(C).
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    3. Agam Shah & Arnav Hiray & Pratvi Shah & Arkaprabha Banerjee & Anushka Singh & Dheeraj Eidnani & Sahasra Chava & Bhaskar Chaudhury & Sudheer Chava, 2024. "Numerical Claim Detection in Finance: A New Financial Dataset, Weak-Supervision Model, and Market Analysis," Papers 2402.11728, arXiv.org, revised Oct 2024.

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    More about this item

    Keywords

    Analyst forecast optimism; Earnings management; Managerial reporting incentives;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G29 - Financial Economics - - Financial Institutions and Services - - - Other
    • M40 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - General

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