The Effect of Management's Credibility and the Form of Their Earnings Forecasts on Investor Judgment
Posted: 14 Oct 1996
Date Written: July 1996
To improve the usefulness of financial reporting, the Jenkins Committee has recommended increased disclosure of forward-looking information. To encourage such disclosures, Congress recently passed legislation providing an enhanced "safe harbor" provision designed to shield companies from legal liability for voluntary disclosure of forecasted financial information that later proves incorrect. The purpose of this paper is to test whether investors' reactions to management's disclosures of forward-looking information depend on two factors: the credibility of management (i.e., their competence and tendency to bias their disclosures) and the form of the forecasted information (i.e., whether it is quantitative or qualitative). Results of two experiments reveal that individual investors' judgments are influenced by the credibility of management. Specifically, we find that investors accord higher stock ratings to companies with managements reputed to be competent; we also observe that investors accord higher ratings to managements who do not tend to bias their disclosures. In contrast to our expectations, we do not observe that quantitative disclosures lead to different stock ratings than qualitative disclosures. Finally, we note that these two factors do not interact in their effects on investor judgment. The implications of our findings and future research directions are discussed.
JEL Classification: M41, G12, C91, D82
Suggested Citation: Suggested Citation