Individual Analyst Forecasts and Tax-Based Earnings Management

Summary

This research summary examines whether company managers adjust reported earnings to meet individual analyst forecasts, beyond the incentive to meet consensus estimates. It describes a study using the change in effective tax rate from the third to fourth fiscal quarter as a proxy for last-chance earnings management. Third-quarter tax rates are used to estimate pre-managed earnings, and the analysis tests whether firms reduce fourth-quarter tax rates when more individual forecasts remain unmet or when a key analyst’s estimate exceeds consensus.

The reported evidence, drawn from company-year observations in 2000–2017, links a larger share of unmet individual forecasts to greater fourth-quarter tax-rate reductions in both firms above and below consensus before management. Key analyst forecasts matter in the below-consensus group, while the corresponding result is not significant for the above-consensus group. The summary also reports robustness analysis using entropy balancing. These are historical findings from overseas research, not a direct trading signal; the tax-rate proxy depends on assumptions about interim estimates, and the study excludes observations with discrete tax items to address a measurement concern.

Key ideas

• Consensus estimates can conceal differences among individual analyst forecasts that managers may consider.
• The study uses the third-to-fourth-quarter change in effective tax rate as a proxy for earnings management.
• A larger share of unmet individual forecasts is associated with larger tax-rate reductions in both firm groups.
• Key analyst estimates show an additional association for firms whose pre-managed earnings fall below consensus.
• The proxy relies on interim tax-rate estimates, and the study excludes observations with discrete tax items.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.