Why do managers meet or slightly beat earnings forecasts in equilibrium?

This study investigates whether and why corporate managers have incentives to meet or slightly beat their own earnings forecasts, and how these incentives are related to their meeting or slightly beating analysts' earnings forecasts. The paper first documents that the frequency of zero and small positive management forecast errors is more than three times the frequency of small negative management forecast errors, consistent with managers having incentives to meet or slightly beat their own forecasts. Next, the paper explains these incentives by developing a formal model in which zero and small positive forecast errors signal that managers have more accurate private information regarding investment opportunities. The accurate information allows managers to select profitable investment projects and consequently increases firm value. Before empirically testing the model, the study provides evidence that analysts follow management forecasts closely and therefore that analysts' forecasts reflect managers' private information. This indicates that the model of managers' private information can be used to explain managers' incentives to meet or slightly beat both managers' and analysts' forecasts. Finally, the paper presents new empirical findings on managers' and analysts' forecasts that are consistent with the model. Specifically, firms that meet or slightly beat managers' or analysts' earnings forecasts perform better in the future; their managers attain a higher reputation and incorporate more private information in the earnings forecasts.PhDAccountingSocial SciencesUniversity of Michigan, Horace H. Rackham School of Graduate Studieshttp://deepblue.lib.umich.edu/bitstream/2027.42/125074/2/3186625.pd