An Examination of the Divergence in Earnings Forecasts between Managers and Analysts

Contrary to the popular emphasis on managers' guiding or walking-down analysts' expectations, analysts' consensus forecasts appear to routinely differ from managers' earnings forecasts. In this paper, we examine how this forecast divergence affects investor response to earnings announcements. Our results suggest that such divergence influences investor evaluation of earnings surprises. Specifically, they lead to, on average, a 31 percent discounting of the valuation of the earnings surprise. The discounting of reported earnings surprises due to forecast divergence is incremental to similar discounting arising from other sources, such as poorer earnings information environments; low persistence of earnings measured by poor earnings quality, extreme earnings, and special items; stale information in management forecasts; and measurement error in management forecasts. This role of forecast divergence at the time of earnings announcements is new in the literature and consistent with investors' reliance on analyst forecasts as earnings benchmark being conditional on the degree of convergence of analyst forecasts with existing management forecasts.