DISAGREEMENT, SPECULATION AND MANAGEMENT FORECASTS

Abstract

Prior theoretical and empirical research has shown that disagreement can cause speculative trading which leads to a speculative premium in stock prices. We examine whether managers take actions to reduce or prolong the disagreement among investors. We establish causality using the exogenous variation in speculative trading after the yearly reconstitution of the Russell 1000/2000 indices. We find that speculative trading reduces the frequency, likelihood, and precision of management forecasts. This relationship is significantly stronger when short-sale constraints are more binding. Consistent with theory, the effect is more pronounced when managers have stronger equity-based incentives. We also find that managers sell equity to benefit from the speculative premium. In summary, our results suggest that managers issue forecasts opportunistically in response to speculative trading – they keep silent whenever possible, and issue fewer and less precise forecasts to prolong disagreement and overpricing.