Earnings Forecast Disclosure Regulation and Earnings Management: Evidence from Taiwan IPO Firms Bikki Jaggi*Faculty of ManagementSchool of BusinessRutgers University - New BrunswickPiscataway, NJ 08854Email: jaggirbs.rutgers.eduTel: (732) 445-3539Chen-lung ChinDepartment of AccountingNational Cheng Chi UniversityTaipei, TaiwanHsiou-wei William LinDepartment and Graduate Institute Of International BusinessNational Taiwan UniversityTaipei, TaiwainPicheng LeeDepartment of AccountingLubin School of BusinessPace UniversityNew York, NY 10038 March 2005*Correspondence AuthorWe received valuable comments at the 2003 American Accounting Association and 2004 Euorpean Accounting Association annual meetings. We also thank the participants at the research seminars at Rutgers University, City University of Hong Kong, and Pace University, for their insightful comments. Picheng Lee especially thanks Pace University for 2003 summer research grant.Earnings Forecast Disclosure Regulation and Earnings Management: Evidence from Taiwan IPO Firms AbstractThis study examines whether the Taiwanese regulation requiring disclosure of earnings forecasts in the IPOs resulted in disclosure of more optimistic or conservative earnings forecasts. Additionally, it examines whether the firms reduced the forecast error by manipulating the reported earnings or revising earnings forecasts to meet the forecast error threshold. The study is based on 759 forecasts issued by the Taiwanese IPO firms from 1994 to 2001, i.e. 8-year period after the regulation was modified to increase the forecast error threshold to 20%.The findings show that the disclosure regulation on earnings forecasts resulted in more optimistic forecasts than conservative forecasts, especially for firms that expected better performance in the forecast year compared to the previous year. Firms, especially those who had optimistic earnings forecasts, engaged more in manipulation of reported earnings than revision of forecasts to meet the forecast error threshold. These findings thus suggest that the disclosure regulation resulted in manipulation of reported earnings, which reduced the earnings quality. Key Words: Earnings Management, Disclosure Regulation, Discretionary Accruals, Mandatory Earnings Forecasts, Forecast Error Threshold. Earnings Forecast Disclosure Regulation and Earnings Management: Evidence from Taiwan IPO Firms I.INTRODUCTIONIn 1991, the Taiwan Securities and Futures Exchange Commission (TSFEC) issued a regulation requiring the IPO firms to include annual earnings forecasts in the IPO prospectuses and also disclose forecasts for two years subsequent to the issuance of IPO The TSFEC issued “Guidelines for Disclosure of Financial Forecasts by Public Companies”, which required the companies desiring to list with the Taiwan Stock Exchange (TSE) to disclose financial forecasts pursuant to the listing. The preparation of financial forecasts shall be subject to the Statements of Financial Accounting Standards No. 16 ”Preparation of Financial Forecasts” published by the Accounting Research and Development Foundation of Republic of China in Taiwan. The underlying objective of this regulation is to reduce asymmetry of information among insiders and investors at large by disseminating forecast information to all potential investors on a fair and equitable basis The TSFECs administrative rule (No. 82-Taiwan-Finance-Securities-(VI)-02581 issued on October 30, 1993) mentions that disclosure of forward looking information will reduce information gap between informed and uninformed traders, and this will finally prevent the use of inside information for making arbitrary profits. . The provision for forecast revision is apparently included in the regulation to encourage firms to revise their forecasts rather than manipulate the reported earnings to meet the forecast error threshold set by the regulation. Lower earnings manipulation is expected to result in better quality of reported earnings and thus improve the usefulness of earnings information of the IPO firms. This study empirically tests whether as a result of this disclosure regulation, more optimistic than conservative forecasts were issued, and whether the expectation of better future operating performance was associated with disclosure of optimistic forecasts. Additionally, it examines whether the forecast error, especially of optimistic forecasts, was reduced by manipulating the reporting earnings using positive discretionary accruals or revising the earnings forecasts. It can be argued that the IPO firms are likely to issue more optimistic forecasts for sending positive signals to the market, and they will especially do so when they expect higher operating performance during the forecast period compared to the previous year. If the forecast error of optimistic forecasts