The Interactive Role of Difficulty and Incentives in Explaining the Annual Earnings Forecast Walkdown

Within-year patterns of analysts’ earnings forecasts are often attributed to incentives to curry favor with managers by releasing optimistic forecasts at longer horizons, followed by a walkdown to levels where actual earnings meet or beat the forecast at year end. We propose that difficulty plays a moderating role in the association between analysts’ incentives to be optimistic and the observed walkdown. If such incentives explain the walkdown of earnings forecasts, we would expect to see a similar pattern for revenue forecasts. However, revenue forecasts are quite accurate at all horizons, with no substantive evidence of any forecast walkdown. Although difficulty should affect forecast error but not optimism, evidence from cognitive psychology implies that in the presence of incentives to be optimistic, greater forecast difficulty for earnings relative to revenues may explain the distinct patterns. Results are consistent with variation in forecast difficulty interacting with analysts’ incentives to be optimistic to explain the observed pattern of annual revenue and earnings forecasts.

This seminar is organised by the Erasmus Accounting Research Group.