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Past Forecasting Errors Often Underestimated When Forecasting Earnings

Weihong Xu

Release date
Nov-06-2009

Contact
Jacqueline Molik Ghosen
716-645-2833
ghosen@buffalo.edu

BUFFALO, N.Y. -- When managers issue a forecast of their firm’s earnings, they do not always take into account prior forecasting errors, according to research recently published in the Journal of Business Finance & Accounting.

Weihong Xu, assistant professor of accounting in the University at Buffalo School of Management analyzed more than 11,000 firm-quarter observations. She found that managers often underestimate the implications of their past forecasting errors when forecasting earnings.

This underestimation of past errors can affect how the market responds to a new earnings forecast. Specifically, it can contribute to “post-earnings announcement drift”; that is, stock prices continue to drift in the direction of the initial price response to an earnings announcement.

“Managers underestimate the information in their prior forecast errors to a greater extent when they make earnings forecasts with a longer horizon,” Xu says.
She notes that further study is needed to see if the underestimation is intentional on the part of management in order to provide biased forecasts.

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