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Image: Shutterstock.com

Image: Shutterstock.com

Reputation and earnings forecasts

20 September 2019

4 minutes read

Wee

Associate Professor Marvin Wee 

Forecasting future earnings is an incredibly important way for companies to set business goals, develop their strategy for the next year and hold themselves internally accountable at the end of the next financial period

Recent research from the ANU College of Business and Economics explores the role that reputation plays for firms when forecasting their earnings for the next year.

Company management and external analysts both produce forecasts about how that company will do financially in the next year. Associate Professor Marvin Wee from the Research School of Accounting investigated the relationship between management forecasts and those done by analysts, hoping to determine how each party values the other’s forecast.

Wee used Japanese companies for this research because, unlike in the US or Australia, all public companies there must disclose an annual forecast of their future revenue. This makes it the perfect context to explore the factors at play in this relationship.

Companies publishing their forecasts in Japan have direct access to their corporate data and first-hand knowledge of internal strategies and sentiments, but analysts often have a better sense of broader market factors and of how other companies are performing.

Management and analyst relationship 

Analysts produce their own forecasts, based on the company’s previous data and on the company forecasts. Wee’s research is a window into how much weight analysts give those company forecasts and in return, how companies revise their outlook based on the analysts. 

“Managers possess private information regarding the firm's underlying performance and are often perceived as having an informational advantage over analysts. However, analysts have more experience predicting future economic conditions and may be able to objectively assess a firm's competitive position and prospects,” says Wee. 

The research highlights the importance of reputation building and reputation maintenance in the forecasting environment.

The research found that both parties determine the value of the other’s forecast through their historical forecasting ability, which is based on their perception of competence and trustworthiness. This means that despite a low risk of litigious fallout, firms still have their reputations to consider when assessing their optimism about future earnings. 

Wee explains, “to our knowledge, earlier studies have not considered the role of analyst forecasts and their associated credibility in informing management forecast revisions. For firms whose performance is heavily affected by external economic factors, the credibility of financial analysts is likely to be an important factor influencing whether managers use analyst forecasts to inform their own forecast revisions.” 

In addition to prior forecasting behaviour, other factors such as the level of external and internal assurance of financial reporting and the inclusion of supplementary information are also likely to affect the perception of credibility.  

“Our findings put the focus on credibility to better understanding the relationship between management and analyst forecasts,” Wee concludes, “each party's reliance on the other's forecast is influenced by historical forecasting ability and in the case of analysts, also by the corporate governance mechanisms within the firm. This highlights the importance of reputation building and reputation maintenance by both management and analysts in the forecasting environment.” 

This research was published in the Pacific-Basin Finance Journal and its abstract is available here. The College is always keen to explore research collaborations with the public and private sector and to reconnect with Alumni. Please get in touch if you would like to know more. 

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Updated:   25 September 2019 / Responsible Officer:  CBE Communications and Outreach / Page Contact:  College Web Team