Managerial Discretion over Initial Earnings Forecasts

Abstract

The main purpose of this study is to investigate managerial discretion over managers’initial management forecasts issued concurrently with earnings announcements. The unique reporting system for management forecasts in Japan, systematic bundled management forecasts, creates an earnings benchmark (i.e., forecast innovations) to which earnings management research has not paid much attention. This study investigates whether and why firm managers manage their initial forecasts to avoid negative forecast innovations. First, we find that managers engage in forecast management through discretionary forecasts to avoid negative forecast innovations. Second, we reveal that 1) firms that avoid negative forecast innovations enjoy a higher return even when they use discretionary forecasts to do so and that 2) the relation between forecast innovations and return is S-shaped. These results suggest that the market rewards firms that achieve a forecast innovation benchmark, providing a sound rationale for managers’ use of forecast management. Finally, our additional analyses suggest that managers are not likely to conduct forecast management to convey their private information on future performance to investors, suggesting opportunistic managerial behaviors concerning their earnings forecasts.