Past Forecasting Errors Often Underestimated When Forecasting Earnings

By Jacqueline Molik Ghosen

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 to provide biased forecasts.

The Wall Street Journal has ranked the UB School of Management No. 9 in the nation among schools with strong regional recruiting bases. In addition, BusinessWeek has ranked the school as one of the country’s top 5 business schools for the fastest return on MBA investment, and Forbes has cited it as one of the best business schools in the U.S. for the return on investment it provides MBA graduates. For more information about the UB School of Management, visit mgt.buffalo.edu.

The University at Buffalo is a premier research-intensive public university, a flagship institution in the State University of New York system and its largest and most comprehensive campus. UB’s more than 28,000 students pursue their academic interests through more than 300 undergraduate, graduate and professional degree programs. Founded in 1846, the University at Buffalo is a member of the Association of American Universities.