A Crystal Ball for Borrowers & Lenders​​

January 2016

When lenders contemplate a debt contract totaling hundreds of millions of dollars, they must analyze volumes of information about the borrower’s past, present, and future operations and investments. While historical data does not guarantee how company management will perform in the future, there is another set of revealing data points. Lenders can compare a company’s performance during a specific period in the past to the forecasts that management made preceding that period. This new research investigates the relationship between the accuracy of those forecasts and the cost of debt to the borrowers.

Are better forecasters better borrowers?
Until now, most accounting research in debt negotiation focused on the quality of the borrower’s reported financial statements and how it affects debt contract terms. In this study, the researchers zero in on the managerial skills needed to forecast and meet financial goals.

“Management forecast accuracy is particularly useful to the lender because it is observable, available at a very low cost, and provides a quantifiable measure that the lender can use during the screening process.”

“We consider management forecast accuracy as an observable signal of the borrower’s ability to anticipate and respond to changing future economic conditions,” explains Jared Jennings. “The borrower’s ability to respond to the future economic conditions is useful to the lender when assessing whether the borrower will be able to make the required future interest and principal payments.”

The researchers predict at the outset of their study that borrowers with more accurate management forecasts would receive a lower cost of debt. To test their hypothesis, they used several databases to construct a sample of nearly 2,500 debt contracts between 2003 and 2012.*

The borrowers and the loan contracts in the sample are described as “large.” Borrowers have average total assets equal to approximately $1.7 billion and median leverage equal to 26% of total assets prior to contract inception. The average contract size in the sample is approximately $800 million with a maturity of 50 months.

The borrower’s historical forecast accuracy is determined with information from the Company Issued Guidance (CIG) and IBES databases. Tables showing each variable used in the analysis are available in the paper available on SSRN.

“We calculate the average managerial forecast accuracy over the three years preceding the loan initiation,” explains Prof. Jennings. “We believe that this forecast accuracy provided a signal to potential lenders on the borrower’s ability to manage into the future.” The researchers found the borrowers with the most accurate forecasts were rewarded with significant cost savings reflected in a nearly 12% reduction in the initial debt contract’s interest spread.

“Using management forecast accuracy as a proxy for the borrower’s ability to anticipate and respond to future economic conditions, we find that borrowers who produce more accurate earnings forecasts receive lower interest rates in private debt contract negotiations.”

Jennings also notes that the results of their study are concentrated among lenders who have not had a previous relationship with the borrower. The researchers found that interest spreads decrease approximately 12% when the borrower’s forecast accuracy moves from the 1st to 10th decile, based on the sample on their study.

If lenders rely on management forecast accuracy as a signal of the borrower’s creditworthiness, the researchers conclude that a great deal is riding on managerial skills and expertise. They argue that, “the same skills and expertise that allows the manager to successfully manage the firm in the future should also lead to more accurate management forecasts; for example, both require accurate projections of future profitability and understanding of the firm’s investment opportunity set.”

In other words: good managers make good forecasters, and good borrowers.

KEY TAKEAWAYS for Managers

For Lenders:

  • Management forecast accuracy is a signal that captures the borrower’s ability to anticipate and respond to future economic conditions
  • Management forecast accuracy allows lenders to improve loan pricing
For Borrowers:
  • Management’s ability to manage a firm into the future affects the cost of capital
  • Sharing forecasts and data that support the accuracy of previous forecasts can be advantageous in debt contract negotiations

*The sample period starts in 2003 to include management forecasts issued prior to contract inception following the passage of Regulation Fair Disclosure (Reg FD), and due to limited forecast data availability prior to 2002 (Chuk et al. 2013).

“Are Better Forecasters Better Borrowers? Management Forecast Accuracy and the Cost of Debt”


Jared Jennings, Assistant Professor of Accounting, Olin Business School, Washington University in St. Louis

Coauthors: Peter Demerjian, Foster School of Business University of Washington; John Donovan, Olin Business School


Under review, The Accounting Review

Image rights: Businessman Consulting Glowing Crystal Ball, Flickr,, Public Domain