The effect of audit report lag and management discretionary report lag on analyst forecasts: Evidence from Korea

Abstract

In this study, it is investigated the relationship between report lags (audit report lag (ARL) and discretionary report lag (DRL)) and analysts' forecast error in Korean firms. Auditing procedures require more effort when earnings management in financial statements is suspected or audit risk is high; this increases ARL. However, the uncertainty of financial statements must be eliminated and transparency in financial statements must be increased. The need is greater in companies with long ARL than in others. In addition, analysts' forecast errors are more numerous in cases of long ARL. Managers have incentives to do two conflicting things: to disclose accounting information as soon as possible, and to delay disclosure as long as possible. When information asymmetry between managers and shareholders is high, managers have incentives to disclose accounting information as soon as possible to reduce information asymmetry. However, managers may delay the release of accounting information when a company is in financial distress or a conflict exists between external auditors and managers. Thus, the disclosure of accounting information may be delayed by managers' opportunistic behavior, thereby increasing DRL. In this case, forecast error increases. The results of the empirical analysis are as follows. First, ARL is positively associated with analysts' forecast error, which increases as ARL increases because information asymmetry intensifies. Second, DRL is negatively associated with analysts' forecast error, which decreases as DRL increases due to improved reliability of financial statements when auditors perform additional audit procedures. In an additional investigation of the relations between ARL, DRL, and forecast bias, the authors learn that analysts forecast future earnings more optimistically as ARL increases, and this tendency decreases as DRL increases. It is also also found that the positive association between ARL and analysts' forecast error is only evident in firm-years in which auditors have long tenure. © Chang-Hyun Bae, Yong-Sang Woo, 2015.