Equity analysts make their living predicting the future of corporate earnings. Yet while capital markets consider the accuracy of analyst forecasts variable at best, many corporate executives feel pressure to reach or even beat these projections. They often go to great lengths to satisfy Wall Street expectations in their financial reporting and even in long-term strategic moves. Academics call this motivation "earnings management," and it has drawn increasing attention from regulators and other market observers. Arthur Levitt, former chairman of the Securities and Exchange Commission, expressed concern that the practice "may be overriding long-established precepts of financial reporting and ethical restraint."¹

So how good are the analysts at predicting earnings and setting forecasts that, whatever their flaws, serve as an important benchmark of the current and future health of companies? To answer this question, and to explore whether there are patterns in analyst forecasts that might enable us to better interpret their projections, we examined aggregate corporate earnings forecasts for companies on the Standard & Poor's 500 index between 1985 and 2001.² Our research shows that analyst forecasts are most often notably overoptimistic, particularly in periods of declining economic growth. The longer the term of the forecast, the...