Implications of Past Forecasting Errors Often Underestimated

Weihong Xu, assistant professor of accounting in the University at Buffalo School of Management, analyzed more than 11,000 firm-quarter observations. She found that managers often underestimate the implications of their past forecasting errors when forecasting earnings.

This underestimation of past errors can affect how the market responds to a new earnings forecast. Specifically, it can contribute to “post-earnings announcement drift;” that is, stock prices continue to drift in the direction of the initial price response to an earnings announcement.

“Managers underestimate the information in their prior forecast errors to a greater extent when they make earnings forecasts with a longer horizon,” Xu says.

She notes that further study is needed to see if the underestimation is intentional on the part of management in order to provide biased forecasts.

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