Gap Between Corporate Earnings, Non-Financial Measures Affects Forecasting

A recent study finds that the more a company’s earnings diverge from its non-financial resources, the less likely it is to issue a forecast of its annual earnings. For companies that issue a forecast, the larger the disconnect between a company’s earnings and its key non-financial measures, the more the company overestimates its actual performance.

Companies often issue forecasts of annual earnings to manage the expectations of investors and the market – but it’s not a requirement,” says Joe Brazel, lead author of the study and Jenkins Distinguished Professor of Accounting in North Carolina State University’s Poole College of Management.

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We were curious about what drives corporate forecasting decisions, and focused on earnings data and non-financial measures.”

Non-financial measures refer to quantifiable, non-monetary aspects of a business that relate to the company’s capacity and performance. These measures include things like the square footage of a company’s facilities, number of employees and number of customers.

For this study, researchers evaluated data from 659 publicly traded companies. The researchers collected 3,786 non-financial measures, or just under six per company. Specifically, the researchers compared each company’s earnings changes to median changes in its non-financial measures. This comparison resulted in a metric that the researchers called the DIFF, which represented the level of divergence between non-financial measures and actual earnings.

We found that the greater the DIFF, the more likely companies were to avoid forecasting,” Brazel says. “This was true whether earnings outpaced non-financial measures, or vice versa. And it makes sense; the larger the DIFF, the more uncertainty a company is likely facing.”

The researchers also found that DIFF could predict forecast errors among those companies that chose to issue forecasts. Specifically, the larger the DIFF, the more a company’s forecast overestimated its actual earnings.

This was somewhat surprising,” Brazel says. “You would expect a company with a high DIFF to make a conservative forecast estimate, but we found the opposite to be true.

The takeaway from this study is that companies with a high DIFF that chose not to issue a forecast were smart,” Brazel says. “Because companies with a high DIFF that did forecast ended up being inaccurate. And the market punishes inaccuracy.”

The paper, “How the Interplay between Financial and Non-Financial Measures Affects Management Forecasting Behavior,” is published in the Journal of Management Accounting Research. The paper was co-authored by Bradley Lail of Baylor University.

*Source: North Carolina State University

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