Voluntary Earnings Forecasts, Investment Decisions, and Earnings Managements

This paper examines a setting in which managers make, in sequence, forecasting, investment, and reporting decisions,when …rms’managers have the option to issue management earnings forecasts (MEF). Managers are assumed to care about the price e¤ects of their actions both at the time they make their voluntary forecasting decisions as well as later on, when they release their …rm’s mandatory reported earnings to the public. Analyzing these multi-period incentives of managers leads to several testable predictions about the relationship between MEF and …rms’investment and earnings management choices. We predict that despite having to bear additional forecast error costs, …rms with better private prospects and those with lower earnings volatility are more likely to issue MEF. Further, we predict that the decision to issue a MEF is associated with higher earnings response coe¢ cients, greater investments, higher expected earnings management, and greater in‡uence of managers’inter-temporal preferences than is the decision not to issue a MEF. We also generate several other empirical predictions regarding the distinct operating attributes of …rms that issue MEF and di¤erent notions of forecast biases.