Do Investment Managers Need Eyeglasses?

Many in the investment community believe that short-term earnings forecasts do more harm than good. Legendary investor Warren Buffett, for example, has called for CEOs to stop issuing quarterly profit forecasts, out of the view that once forecasts are set, companies focus almost exclusively on making sure their predictions come true. 

“There’s a common criticism by Buffett and others that investment managers are myopic,” explains the Zicklin School’s Associate Professor Svenja Dube, PhD (Stan Ross Department of Accountancy). “They think managers turn their short-term forecasts into self-fulfilling prophecies, such that they’ll even destroy firm value in the long run in order to meet their own predictions.” 

At the same time, without guidance from managers in the form of these forecasts and predictions, investors and potential investors will be more uncertain about a company’s value. Is it worth investing in, or not? Theoretically, the more information investors have, the better their understanding of firm value, giving managers a clear incentive to issue forecasts. 

Dr. Dube decided to study this vexing question in a very specific context: research and development (R&D). R&D investment is inherently risky—a pharmaceutical company might spend millions of dollars developing a potential drug, only to have it fail in a Phase 3 clinical trial. 

“In R&D-intensive companies, both managers and investors face uncertainty,” Dube notes. “Normally, investor uncertainty puts pressure on managers to provide projections and forecasts, but the volatility of R&D investment creates a dilemma for managers: Do they provide a projection that might be wrong, or do they provide nothing, which might make investors less inclined to invest?” 

Dube’s recent article, “Trading off managerial and investor uncertainty in firm disclosure: Evidence from R&D investments and management guidance,” examines this paradox and was based on the dissertation she wrote for her PhD degree in accounting from New York University. Her findings, published in Contemporary Accounting Research, were somewhat surprising. 

“One might expect that, in an uncertain environment, managers would be less likely to provide short-term earnings guidance in the form of quarterly forecasts, but the opposite turned out to be true,” Dube says. “They don’t dial back on short-term disclosures, but they do dial back on long-term disclosures—say, two to three years out. In the end, I argue that providing short-term investment guidance might not be myopic, because managers use it as a substitute for long-term guidance that they don’t feel comfortable providing.” 

Looks like investment managers might want to cancel their next ophthalmology appointment! 

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