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. JEL Descriptors G19, G39, D89, M40 * Corresponding Author: ahutton@bc.edu; 617 552-1951 phone; 617 552-6345 fax; Fulton Hall 520, 140 Commonwealth Ave. Chestnut Hill, MA 02467-3808 *We thank Ray Ball, Steve Baginski, Linda Bamber, Ken French, Charles Hsu, Michael Kimbrough, S.P. Kothari, Rafael La Porta, Franco Wong, Eric Yeung, Valentina Zamora, an anonymous referee, and workshop participants at Boston College, Boston University, Carnegie Mellon University, Emory University, INSEAD, University of Georgia, MIT Sloan School of Management, Tuck School of Business, George Washington University, FEA Conference at the University of North Carolina, Chapel Hill and the 2006 American Accounting Association annual meetings for helpful comments. Finally, we thank Robert Burnham for excellent research assistance.