Biases in Multi-Year Management Financial Forecasts: Evidence From Private Venture-Backed U.S. Companies

This paper studies the properties and determinants of managers’ multi-year financial forecasts. We ask whether, by how much, and why biases in managers’ forecasts of revenues, expenses and profits depend on the forecasting horizon and the verifiability of firms’ assets. Since public companies rarely divulge their internal multi-year financial projections to outsiders, we use the oneto five-year-ahead management forecasts reported by private venture-backed firms. We also introduce a new method of measuring financial forecast bias that compares forecasts to historically-grounded conditional projections, rather than to ex-post actuals. We find that on average, managers’ forecasts of firm profitability and revenues are optimistic, especially as the forecast horizon increases to five-years-ahead. Managers’ expense forecasts become more pessimistic as the forecast horizon rises, most likely arising from the need on managers’ part to respect ‘reasonable’ relations between revenues and expenses. We conclude that profitability forecasts contain a strategic component, in that: [1] One-year-ahead revenue (expense) forecasts are slightly and asymmetrically pessimistic (optimistic), and five-year-ahead forecasts are hugely and asymmetrically optimistic (pessimistic); and [2] Biases in revenue and expense forecasts are larger the harder to verify or more intangible-intensive are firms’ assets. JEL classifications: G24, M13, M41.