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Soft-Talk Management Cash Flow Forecasts: Bias, Quality, and Stock Price Effects

We exploit a novel feature of management cash flow forecasts (MCFFs) to investigate how managers’ discretion over forecast precision, clarity, and verifiability affects the bias, quality, and stock price effects of such forecasts. Many MCFFs are issued with an equivocal definition of the cash flow number being forecasted. We refer to such forecasts as “Soft-Talk” MCFFs and predict, due to their lower precision and clarity, potential for bias, and low ex-post verifiability, that they will have lower disclosure quality and lower credibility with investors when compared to “GAAP-Based” MCFFs. “GAAP-Based” MCFFs are those whose cash flow definition is associated with a GAAP cash flow measure (e.g., OCF or NCF), one that can be derived from GAAP cash flow measures (e.g., free cash flow, FCF), or one where management explicitly discloses the definition of cash flow. We find that “Soft-Talk” MCFFs are optimistically biased and that managers’ decision to issue “Soft-Talk” MCFFs is related to economic factors including litigation risk, actual cash flow performance, industry concentration, and the issuance of prior cash flow forecasts. As predicted, “Soft-Talk” MCFFs have lower disclosure quality than “GAAP-Based” MCFFs. Finally, while MCFFs in general affect stock prices, consistent with the low precision and clarity, and potential for optimistic bias in “Soft-Talk” MCFFs, they have no effect on stock prices. Our findings document how and why managers’ discretion over forecast precision, clarity, and verifiability affects the bias, quality, and stock price effects of such forecasts.