Evidence That Management Earnings Forecasts Do Not Fully Incorporate Information in Prior Forecast Errors

Authors

  • Weihong Xu

    1. The author is from the Department of Accounting and Law, State University of New York at Buffalo. She appreciates the helpful comments provided by Joseph Comprix, Martin Walker (editor) and an anonymous referee. She gratefully acknowledges the summer research support from the School of Management at the State University of New York at Buffalo.
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* Address for correspondence: Weihong Xu, Department of Accounting and Law, State University of New York at Buffalo, Buffalo, NY 14260, USA.
e-mail: wxu4@buffalo.edu

Abstract

Abstract:  This paper investigates whether managers fully incorporate the implications of their prior earnings forecast errors into their future earnings forecasts and, if not, whether this behavior is related to the post-earnings announcement drift. I find a positive association in consecutive management forecast errors, suggesting that managers underestimate the future implications of past earnings information when forecasting earnings. I also find that managers underestimate the information in their prior forecast errors to a greater extent when they make earnings forecasts with a longer horizon. Finally, I find that, similar to managers, the market also underreacts to earnings information in management forecast errors, which leads to predictable stock returns following earnings announcements.

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