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Range has it: decoding the information content of forecast ranges

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Abstract

Range forecasts have emerged as the predominant form of management forecasts, but prior research has overlooked the information conveyed by forecast ranges. This study fills this void by examining the information content of the extent to which managers’ forecast ranges overlap with the range of individual analysts’ pre-existing estimates (i.e., overlap). We expect managers to signal their superior private information by issuing low-overlap forecasts. We predict and find that, compared with high-overlap forecasts, low-overlap forecasts are associated with stronger market reactions and higher accuracy of management forecasts relative to analyst estimates. Moreover, when responding to low-overlap management forecasts, analysts with prior estimates out of management forecast ranges are more likely to revise into the management forecast range, less likely to revise toward the consensus, and more likely to improve in revised forecast accuracy. Our findings suggest that investors and analysts view low-overlap management forecasts as signals of superior private information.

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Notes

  1. We note that AF range is a pseudo range as it is formed by a set of point estimates. We follow the literature to define AF range as the range formed by the highest and the lowest analyst estimates (e.g., Atiase and Bamber 1994).

  2. The prediction is by no means obvious as several reasons exist for the opposite prediction. (1) The news magnitude of low-overlap forecasts is bigger on average, likely resulting in lower response per unit of news. (2) Managers’ credibility may be questioned if their forecasts deviate from the majority of analyst estimates. And (3) high-overlap forecasts confirm market expectations and reduce uncertainty, likely increasing the response to per unit of news.

  3. Although we use Perc_Overlap as our primary overlap measure, we also use an indicator variable D_Overlap, essentially comparing the case of Perc_Overlap = 0 with the average case of Perc_Overlap > 0.

  4. For parsimony, the plot presents the question as a dichotomy, but a more realistic interpretation is that managers are informed to various degrees, with the “uninformed” managers representing the least informed managers.

  5. In this case, managers may also consider not issuing any forecast, but this is unlikely given the benefits of issuing confirmatory forecasts (e.g., Clement et al. 2003). Because nonforecast observations do not enter our sample, this possibility should not affect our empirical predictions and analyses.

  6. Hilary and Hsu (2011) document that overconfident managers tend to overweight their own information (underweight analysts’ information) and tend to issue forecasts with narrower ranges.

  7. The purpose of Figure 2 is to help frame our predictions on comparing high- and low-overlap forecasts because the extent of overlap is our variable of interest and it is observable. Empirically it is difficult to differentiate the various cases in Figure 2 because the underlying reasons for issuing high- or low- overlap forecasts are unobservable.

  8. We obtain qualitatively the same results if we use the mean, instead of median, analyst forecast as analyst consensus or if we calculate GuideNews with the upper/lower bound of management range forecasts (e.g., Ciconte III et al. 2014).

  9. We convert continuous variables AFDisp, MFRange, Coverage, Size, BM, Horizon, IO, and Skew into indicator variables based on their medians to facilitate the interpretation of the coefficients on interaction items.

  10. Our results are robust to measuring MFRA with either the upper or the lower bound of management forecast range.

  11. If no management forecast was issued in the same fiscal quarter, then the last forecast in the prior year is used.

  12. We use I/B/E/S database because First Call discontinued its coverage of management earnings forecasts after 2011. Our sample period starts from 2003, due to I/B/E/S’s limited coverage of management forecasts prior to 2003.

  13. We use the detailed historical adjusted file for analyst estimates and actual earnings to ensure that management forecasts, analyst estimates, and actual earnings are all on the same basis.

  14. The number of analysts ranges from 1 to 37, with a mean (median) of 4.3 (3). 42.6% of management forecasts are preceded by fewer than three analyst estimates and thus are deleted. If an analyst issues multiple estimates, we use the analyst’s last estimate in constructing the range of analyst estimates.

  15. For management forecasts without bundled earnings news, EANews is set to 0 in our regression analyses. Besides, our results remain qualitatively the same if we exclude all bundled management forecasts from our sample.

  16. The results are similar if we replace analyst forecast dispersion with analyst forecast range width; the correlation between the two variables is 0.97.

  17. We calculate the economic magnitude of the response coefficient relative to the coefficient on the main effect.

  18. We thank an anonymous reviewer for pointing out that D_Overlap = 0 if and only if the distance between the midpoint of management range forecast and the “midpoint” of analyst forecast range is greater than the average forecast range width (0.5× [management forecast range width + analyst forecast range width]).

  19. Larger magnitude of forecast news does not necessarily lead to larger market reactions to per unit of news. On the contrary, untabulated results show that stock returns react less strongly to forecasts news of higher magnitude (on a per unit news basis) in our sample, consistent with the S-shape earnings-return relation documented in prior studies (Freeman and Tse 1992; Kothari 2001; Rogers and Van Buskirk 2013). This S-shape relationship is also reflected by the negative coefficient on GuideNews× ABSGuideNews in the stock return test results in Table 3.

  20. The matched width is within 5% apart. It does not affect our results if we match on management forecast width, instead of the average width, without replacement and without restricting to the same time period, firm, or industry.

  21. Because our logistic regressions include fixed effects, we calculate the average marginal effect as the difference in the average predicted MFRA when Perc_Overlap is at its first quartile versus at its third quartile. We use the same approach when we calculate the average marginal effect in our individual-analyst-level analyses later in the paper.

  22. The differential analyst reactions to positive and negative news are likely due to analysts’ incentives to lowball forecasts (Hilary and Hsu 2013); thus the effect of overlap is insignificant in influencing analysts’ upward revisions.

  23. Our results remain qualitatively the same if we use a subsample of unbundled management forecasts for the tests in Tables 6, 7, and 8, except that the coefficients on overlap in columns (3) and (4) of Table 8 become insignificant, likely due to weaker test power with a much smaller sample.

  24. In our main tests of individual forecast revisions, we measure earnings news (EANews) using analyst consensus. However, an individual analyst’s forecast revision could be affected by bundled quarterly earnings that is interpreted by the analyst’s own quarterly estimate. (We thank an anonymous referee for pointing out this possibility.) For example, for analysts whose prior annual earnings estimates are above the upper bound of managers’ annual forecasts, these analysts are more likely to revise downward into management forecast ranges if their own quarterly estimates are higher than the bundled quarterly earnings. To take this into account, we measure EANews based on individual analyst’s own estimate, and we obtain similar results to those reported in Tables 6, 7, and 8.

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Acknowledgments

We are grateful for the financial support of our respective institutions, and we are thankful for many helpful comments and suggestions from Richard Sloan (the editor), two anonymous referees, as well as Jeremy Bertomeu, Suresh Govindaraj, Hai Lu (discussant), Lakshmanan Shivakumar, Jenny Tucker (discussant), Paul Zarowin, and workshop participants from Montclair State University, New York University, Rutgers University, Singapore Management University, Southern Methodist University, St. John’s University, Stony Brook University, University of British Columbia, University of Chile, University of Glasgow, University of Puerto Rico, Baruch-Fordham-Rutgers Accounting Research Symposium, Conference on Financial Economics and Accounting (CFEA), Hawaii Accounting Research Conference (HARC) and Temple University Accounting Conference.

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Authors and Affiliations

  1. Stern School of Business, New York University, New York, NY, USA

    Michael Tang

  2. Rutgers Business School, Rutgers University, Newark, NJ, USA

    Li Zhang

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Correspondence to Michael Tang.

Appendix

Appendix

1.1 Variable Definitions

Dependent Variables:

ABN_RET :

the size-adjusted buy-and-hold stock return from trading day −1 to +1 centering on the management forecast announcement date.

ABN_VOL :

the average trading volume from trading day −1 to +1 centering on the management forecast announcement date, scaled by the median trading volume in the prior 60 days.

MFRA :

an indicator variable that equals 1 if the management forecast is more accurate than the analyst consensus forecast and 0 otherwise.

ERATIO :

the absolute value of the analyst forecast error divided by the absolute value of management forecast error.

D_ALIGN :

an indicator variable that equals 1 if the analyst forecast moves into management forecast range and 0 otherwise.

D_HERD :

an indicator variable that equals 1 if the analyst herds toward the analyst consensus forecast and 0 otherwise.

D_IMPROVE :

an indicator variable that equals 1 if the revised analyst forecast following the issuance of the management forecast is more accurate (compared to actual earnings) than the one before the management forecast and 0 otherwise.

Independent Variables:

Perc_Overlap :

the percentage of analyst forecasts falling within the management forecast range.

D_Overlap :

an indicator variable that equals 1 if the management forecast range covers some or all of the prevailing analyst forecasts and 0 otherwise.

GuideNews :

the midpoint of a management range forecast minus the prevailing median analyst forecast, scaled by the stock price at the prior month end.

AFDisp :

the standard deviation of the prevailing analyst forecasts, deflated by the stock price at the prior month end.

MFRange :

the upper bound of the management forecast range minus the lower bound, deflated by the stock price at the prior month end.

ABSGuideNews :

the absolute value of GuideNews.

Coverage :

the logged value of the number of analysts providing forecasts in the 60 days prior to the management forecast.

Size :

the logged value of the market value of equity prior to the management forecast.

BM :

the book value of equity divided by the market value equity prior to the management forecast.

Horizon :

the number of days between management forecast announcement date and the forecast period end date, scaled by 360.

Fq2 :

an indicator variable that equals 1 if a management forecast is announced in the second fiscal quarter and 0 otherwise.

Fq3 :

an indicator variable that equals 1 if a management forecast is announced in the third fiscal quarter and 0 otherwise.

Fq4 :

an indicator variable that equals 1 if a management forecast is announced in the fourth fiscal quarter and 0 otherwise.

IO :

the percentage of shares held by institutional investors prior to the management forecast.

HighRevVol :

an indicator variable that equals 1 if the revenue volatility (the standard deviation of revenues scaled by the average revenue in the prior 12 quarters) is in the top quintile and 0 otherwise.

HighInventory :

an indicator variable that equals 1 if the inventory level (standardized by total assets) is in the top quintile and 0 otherwise.

Loss :

an indicator variable that equals 1 if the midpoint of management range forecast is negative and 0 otherwise.

Skew :

the difference between the mean and the median of analyst forecasts, deflated by the stock price at the prior month end and multiplied by 100.

EANews :

the actual earnings announced along with a management forecast minus the consensus analyst forecast for the actual earnings, scaled by the stock price at the prior quarter end. If there is no bundled earnings announcement, EANews is set to 0.

ABSEANews :

the absolute value of EANews.

Prior_Ret :

the cumulative stock return in the 90 days prior to the management forecast.

Bundle :

an indicator variable that equals 1 if there are actual earnings announced along with the management forecast and 0 otherwise.

GuideNews_Good :

GuideNews if the midpoint of a management range forecast is higher or equal to the prevailing analyst consensus and 0 otherwise.

GuideNews_Bad :

GuideNews if the midpoint of a management range forecast is lower than the prevailing analyst consensus and 0 otherwise.

BadNews :

an indicator variable that equals 1 if the midpoint of management range forecast is lower than the prevailing analyst consensus and 0 otherwise.

Lag_MFRA :

an indicator variable that equals 1 if the management forecast announced in the same fiscal quarter last year is more accurate than the analyst consensus forecast and 0 otherwise. If there is no management forecast issued in the same fiscal quarter last year, the last management forecast issued in the prior year is used.

Lag_ForecastError :

the forecast error of the management forecast announced in the same fiscal quarter last year. If there is no management forecast issued in the same fiscal quarter last year, the last management forecast issued in the prior year is used. Forecast error is calculated as −1× |midpoint of management range forecast-actual earnings|.

Distance :

the distance between out-of-range analyst forecasts and the closest bound of management range forecasts, deflated by the stock price at the prior month’s end.

LastActualIn :

an indicator variable that equals 1 if the prior year’s actual earnings are in the range of the management forecast announced in the same fiscal quarter last year and 0 otherwise. If there is no management forecast issued in the same fiscal quarter last year, the last management forecast issued in the prior year is used.

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Tang, M., Zhang, L. Range has it: decoding the information content of forecast ranges. Rev Account Stud 23, 589–621 (2018). https://doi.org/10.1007/s11142-018-9441-7

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