Impact of Tournament Incentives on Management Earnings Forecasts

This paper examines how rank-order tournament incentives in the top management team (TMT) influence the quality of management earnings forecasts (MEFs). Instead of breeding feelings of inequality and fostering peer sabotage, the large pay gap between the CEO and subordinates may motivate top executives to issue more accurate and precise forecasts to win the prize of promotion. The positive tournament effect on the quality of MEFs is weakened (strengthened) when the perceived probability of promotion for candidates is low (high). We find that firms with higher tournament incentives are more likely to issue supplementary forecasts to increase the credibility of MEFs. By examining the tournament effect at each subordinate manager level, we find that CFOs are the driving force in controlling the frequency and quality of management forecasts and chief marketing officers (CMOs) may also contribute to the quality of management forecasts. The results are robust to multiple measures of tournament incentives and multiple research designs.

Prior Forecasting Accuracy and Investor Reaction to Management Earnings Forecasts

We examine the properties of firms’ forecasting records and whether the accuracy of their prior earnings forecasts affects investor response to their subsequent forecasts. Within the context of a Bayesian model of investor learning, we find that the stock price response to management forecast news is increasing in prior forecast accuracy and also in the length of a firm’s forecasting record. Further, we document that investors are more responsive to extreme good and bad news forecasts when a firm has an established forecasting record. Overall, these results suggest that a firm’s prior forecasting behavior allows it to establish a forecasting reputation, and that market forces encourage accurate forecasting as firms benefit from having a reputation for forecasting accurately.