Analysts may provide optimistic forecasts to meet the incentives of bonuses at the end of an accounting period. The risk of optimistic forecasts is that it may overestimate the performance of the firm (Whalen, Baginski, & Bradshaw, 2018). An example of the risk of overestimating performance is if analysts determine that the firm will earn $5 million in net income in the upcoming year. Because of this estimate, the managers decide to increase their capital leverage structure through additional debt. In actuality, the firm only earns $1 million in net income, which leads to difficulties in the firm paying off those debts.

On the other hand, analysts may provide conservative estimates to attempt the conservation of resources for the firm. The risk of underestimating the performance of a firm is that investors will determine that the firm is not profitable and will withdraw any capital contributions (Whalen et al., 2018). An example of this risk occurs when a firm estimates it will earn $2.5 million in net income compared to the industry average of $6 million in net income. Because there is a $3.5 million difference, investors would most likely reject support through the capital for the firm due to the estimated lower chances of returns for investors.

Timothy

References

Whalen, J., Baginski, S., & Bradshaw, M. (2018). Financial reporting, financial statement

analysis and valuation (9th ed.). [Adobe Digital Editions version]. Retrieved from

https://www.gcumedia.com/digital-resources/cengage/2018/financial-reporting-financial-

statement-analysis-and-valuation_9e.php