Do Analysts Account for Earnings Management?

Abstract

We examine whether analysts include the managed earnings component in their forecasts or are surprised by the managed earnings component. We also investigate whether analysts’ earnings forecasts for future periods and their stock recommendations are affected by earnings management in the current period. The results, based on a sample of 583 restatements and a much larger sample of cases where earnings are likely to have been managed upward, are consistent with analysts forecasting the managed earnings number. Further, the managed earnings component appears to influence analysts’ subsequent earnings forecasts, leading to upward forecast revisions and upgraded stock recommendations which appear to be unwarranted given the firms’ subsequent operating performance.

Keywords: Financial Analysts, Earnings Forecasts, Forecast Efficiency

JEL Classification: C53, D83, G14, G29, M41, M43