ABSTRACT We examine whether analysts' incentives to maintain good relationships with management contribute to the optimistic/pessimistic within‐period time trend in analysts' forecasts. In our experiments, 81 experienced sell‐side analysts from two brokerage firms predict earnings based on historical information and management guidance. Analysts' forecasts exhibit an optimistic/pessimistic pattern across the two timing conditions (early and late in the quarter), and the effect is significantly stronger when the analysts have a good relationship with management than when their only incentive is to be accurate. Debriefing results indicate that analysts are aware of this pattern of forecasts, and believe that this benefits their future relationships with management and with brokerage clients. The analysts most frequently cite favored conference call participation and information access when describing benefits from maintaining good relationships with management. Our results suggest the following: The optimistic/pessimistic pattern in forecasts is in part a conscious response to relationship incentives, information access is perceived to be a major benefit of management relationships, and recent regulatory changes may have lessened but have not eliminated this conflict of interest source.

ABSTRACT: The trend toward continuous monitoring of automated business transactions by the internal audit function is growing as organizations seek to improve internal control. In this study, we demonstrate that continuous monitoring and the time horizon over which performance-contingent incentives are based can interact, thereby yielding potential functional and dysfunctional effects on managerial decisions. Seventy-two experienced corporate managers completed a between-participants experiment that randomized monitoring frequency (periodic or continuous) and incentive horizon (short-term or long-term). We found that earnings management of real activities significantly decreased as the frequency of monitoring increased in the presence of a short-term incentive horizon—a functional effect. However, with a long-term incentive horizon, the participants’ willingness to change the current level of investment in a risky but viable project significantly dropped as the frequency of monitoring increased, even though additional investment would enhance the likelihood of the project’s eventual success—a dysfunctional effect. We also observed that more frequent monitoring significantly decreased the willingness of managers to continue with a risky but viable project regardless of incentive horizon and the effect was significantly pronounced in the presence of a short-term, relative to long-term, incentive horizon—another dysfunctional consequence. Implications of the research findings to theory and practice are discussed.