The Relation between Internal Forecasting Sophistication and Accounting Misreporting

Abstract

We examine the association between internal forecasting sophistication and end-of-the-year accounting misreporting. We draw on survey data from investment center managers of Dutch companies. Consistent with our hypothesis, results suggest that more sophisticated internal forecasting allows firms to reduce their costly accounting misreporting as these firms make more accurate projections and create contingency plans such that they can revise operational plans in a more appropriate and timely manner. Cross-sectional analyses reveal that the benefits in terms of greater forecasting capabilities can vary across conditions. We find that investments in internal forecasting are less effective in reducing the demand for misreporting when environmental volatility is high, when capital market pressure to meet expectations is comparably high, and when within-firm information asymmetry is high. The paper especially speaks to the planning role of budgeting and forecasting, as opposed to the relatively more extensively studied evaluation and incentive role.