Management Forecast Optimism During Credit Watch and Credit Rating Agencies’ Disciplinary Role

Abstract

This study investigates management forecast optimism and credit rating agencies’ role in disciplining opportunistic managerial disclosures in the setting of credit watch reviews. Our analysis shows that managers are generally more likely to issue earnings forecasts and to optimistically bias their forecasts during credit watch periods than in non-watch periods. However, their forecast optimism declines when the rating agency involved has a stronger incentive or ability to monitor, such as when it has low conflict of interest or less difficulty detecting bias in disclosures. In such cases, the rating agency is more likely to penalize managers’ watch-period forecast optimism via unfavorable watch resolutions. Our study provides new evidence on opportunistic voluntary disclosures during credit-related events and credit rating agencies’ monitoring role (or lack thereof) in disciplining misrepresentation in voluntary disclosures.