Smooth Earnings and the Credibility of Management Forecasts

This paper examines the relation between smooth past earnings performance and the credibility of voluntary management earnings forecasts. Specifically, using strings of increasing earnings per share as our measure of past performance, we demonstrate that both analyst forecast revisions and stock price reactions around management earnings forecasts are more pronounced when the firm has posted a string of recent earnings per share increases. These results are consistent with our primary hypothesis that voluntary management earnings forecasts are more believable when they are made by firms with long patterns of increasing earnings per share. Additional analysis suggests that such forecasts are also more accurate relative to ex post realized earnings and are more effective in reducing the dispersion in analysts' expectations of future earnings.