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 forecasts, and whether these incentives are related to their meeting or slightly beating analysts’ forecasts. After documenting that managers have incentives to meet or slightly beat their own forecasts, the paper formally models meeting or slightly beating forecasts as a signal that managers have more accurate private information regarding investment opportunities. The accurate information enables managers to invest in profitable projects and consequently increases the firm value. The paper then empirically tests the model using both managers’ and analysts’ forecasts. Analysts’ forecasts are used because analysts follow management guidance closely. Consistent with the model, firms that meet or slightly beat managers’ or analysts’ earnings forecasts perform better in the future, attain a higher reputation, and have more private information in their forecasts than both firms that miss earnings forecasts and firms that beat forecasts by a larger margin. This study is from my dissertation. I am extremely grateful to my committee members: Raffi Indjejikian, Robert Keener, Vikram Nanda, and Douglas Skinner (Chair) for their comments and support. I would also like to thank the following for their helpful comments and discussions: Carol Anilowski, Judson Caskey, Harry Evans, Russell Lundholm, Sarah McVay, Venky Nagar, Dan Weimer, Kathy Yuan, and the brownbag and seminar participants at the Hong Kong University of Science and Technology, the University of Houston, the University of Illinois at Urbana-Champion, London Business School, the University of Michigan, New York University, the University of Pittsburgh, and the University of Waterloo. I gratefully acknowledge the financial support of the Paton Fund and the University of Michigan Business School.