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Earnings Forecasts: The Uses Of Pseudo-Precision

Earnings Forecasts: The Uses Of Pseudo-Precision
Value Walk
Published: May 24, 2017

Impressed by the precision of a company’s earnings forecast? New study urges caution
Perhaps in support of the remark attributed to Yogi Berra that “it’s tough to make predictions especially about the future,” research has consistently shown precise-sounding forecasts to have strong impacts, both in bolstering the self-image of those who make them and in impressing those to whom they are made.

Still, precision would seem hazardous for corporate executives when forecasts are as keenly scrutinized as those they make about their firms’ future earnings. Citing a prior research estimate that company leaders meet their earnings forecasts only about six percent of the time, a new study begins by asking, “Why would top managers issue very precise judgment, particularly in the crucial domain of earnings forecasts or guidance of next year’s earnings, given that such precise judgment potentially induces errors and erodes their credibility?”

What the paper in the June issue of the Academy of Management Journal concludes will not be encouraging to investors. Management forecasts that are relatively precise, it finds, generally do not derive from any special insight by the leaders who issue them and more likely represent an effort at impression management in the wake of company failures or stumbles.

And, yet, such is the mystique of precision – or what is referred to in the study’s title as “pseudo-precision” – that the tactic evidently works.

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