When it comes to forecasting future earnings, no one wants to rain on a company’s parade, but new research suggests that a little drizzle might dampen optimism in a healthy way.
In a forthcoming study for The Accounting Review, Accounting Professor Lisa M. Sedor and two colleagues looked at ways analysts can avoid being influenced by the often-rosy stories managers tell about the future.
“Optimism in analysts’ forecasts is costly to investors,” argue the authors, so “reducing optimism...could also result in higher returns for investors relying on analysts’ recommendations.”
In two experiments with professional financial analysts and MBA students, the authors found that simply asking analysts to generate a few “counter-explanations” (that is, reasons why managers’ plans could fail) led them to make significantly less confident assessments of future firm performance.
The research is important, Sedor says, “because it’s the first to suggest the use of counter-explanations as a simple tool for removing the rose-colored glasses and reducing optimism in analysts’ earnings predictions.”