Review of Quantitative Finance and Accounting, 21: 103–122, 2003
2003 Kluwer Academic Publishers. Manufactured in The Netherlands.
Analysts’ Rationality and Forecast Bias:
Evidence from Sales Forecasts
DAVID P. MEST
Stillman School of Business, Seton Hall University, 400 South Orange Avenue, South Orange, NJ 07079
Department of Accounting, College of Business Administration, University of North Texas, P.O. Box 305219,
Denton, TX 76203-5219, USA Tel.: 940-565-3080
Abstract. When optimistic forecasts can improve access to management, rational analysts have incentives to
issue optimistically-biased forecasts (Lim, 2001). This paper proposes that the extent of this optimistic forecast bias
will depend on the forecast’s importance to management. If management attaches less importance to a forecasted
measure, analysts should decrease their forecast bias because the expected beneﬁts of issuing optimistic forecasts
are less. We examine analysts’ earnings and sales forecasts, and predict that analysts’ optimistic bias will be greater
for earnings than for sales. Results are consistent with our predictions and contribute to the evidence that analysts’
forecast bias is rational and intentional.
Key words: analysts’ forecasts, bias, rationality, earnings, sales
JEL Classiﬁcation: M4, C5
Numerous studies show that analysts’ earnings forecasts are overly optimistic.
this optimistic bias, researchers often conclude that analysts’ forecasts are suboptimal or
irrational. Lim (2001) argues that optimistic forecasts may be optimal from the analyst’s
perspective. He proposes a model in which rational analysts intentionally bias earnings
forecasts upward in order to gain management’s favor and improve access to company
management. Management is an important source of information for analysts, and man-
agers prefer favorable earnings forecasts because they justify higher equity values. Higher
equity values provide managers with higher compensation levels (via more valuable stock
options) and improve investors’ assessment of management’s job performance. Evidence
also suggests that management penalizes analysts who issue unfavorable forecasts by re-
stricting the amount of information shared with them.
By gaining management’s favor
and improving access to management, analysts can improve their information about the
company, and thus increase their forecast accuracy.