Earnings Forecasts of Firms Experiencing Sales Decline

Abstract

Many studies show that earnings forecasts of poor-performance firms contain large errors (Kothari et al. [2005], Brown [2001], Hwang et al. [1996], and Elgers and Lo [1994]). Why are these forecasts so inaccurate? This article demonstrates that inflexible costs, as captured through operating and financial leverage above the industry's normal range, are associated with large forecast errors during sales decline. The results are useful in helping investment managers better evaluate analyst forecast ability, and help analysts improve their forecasts by better anticipating the impact of inflexible costs on earnings