The Effect of Manager Forecast of Future Sales on Company Risk During Sales Decline Using the Fama-French Five-Factor Model

The Effect of Manager Forecast of Future Sales on Company Risk During Sales Decline Using the Fama-French Five-Factor Model Zahra Moghadam1, Gholamreza Mansourfar2, Hamzeh Didar2 1. PhD Student, Department of Accounting, Faculty of Economics and Management, Urmia University, Urmia, Iran 2. Associate Professor, Department of Accounting, Faculty of Economics and Management, Urmia University, Urmia, Iran (Received: January 22, 2020; Revised: January 2, 2021; Accepted: January 9, 2021) Abstract A sales decline period disrupts the time series of earnings and, consequently, reduces their predictability. Such a situation can lead to inappropriate decisions by investors. Therefore, managers need to respond appropriately to negative news resulting from sales decline. Manager response is related to forecasting future sales situations, which could affect risk to the firm. Accordingly, the purpose of this study is to investigate the effect of managers' forecasts of future sales on the risk of companies that have experienced sales decline. In this study, the ratio of the changes in operating profit margin was used to compare companies with optimistic and pessimistic managers. To investigate the research hypotheses, the Fama-French five-factor model was used to depict a period of 11 years, from 2007 to 2017, for the companies that are accepted in the Tehran Stock Exchange. It should be noted that the market beta of the Fama-French five-factor model is distinguished by upside potential and downside risk factors, making it possible to study them individually. The findings imply that in companies with optimistic managers, the upside potential is more than the downside risk, but in companies with pessimistic managers, there is no significant difference between the upside potential and the downside risk. Keywords: Sales decline, Upside potential, Downside risk, Fama-French five-factor model, Fama French six-factor model. Introduction A sales decline period can lead to investor confusion and wrong decisions due to variation in the earnings-time series. Therefore, during sales decline, managers must respond correctly to negative news arising from sales and profit decline to restructure the normal and expected profit pattern of investors. Capital market studies have confirmed that the perception of analysts and investors regarding costs behavior is less accurate because of ‘sticky costs’ behavior when sales decline is expected (Ciftci et al., 2015). The traditional cost behavior pattern, regardless of the role of managers in the adjustment process and application of resources, associates costs with levels of activities and classifies the costs as fixed or varied based on the level of activity. On the contrary, the findings of some researchers such as Anderson et al. (2003; 2007) and Calleja et al. (2006) indicate that the rate of cost increase during a booming sales period is more remarkable than the cost decrease at the same level of sales decline. In management accounting, this is called the ‘stickiness of cost.’ Previous studies have confirmed, however, that the capital market analysts and investors cannot Corresponding Author, Email: 510 Moghadam et al. perceive the cost behaviors resulting from resource adjustment decisions by managers (Weiss, 2010). On the one hand, maintaining slack resources during sales decline periods (which arise from manager optimistic expectations of the profitability and future demands) imposes some costs during the current period and decreases the profitability. On the other hand, the manager’s withdrawal of the resources (which arises from their pessimistic expectations of future demands) improves their profitability in the current period (Jholanjehad et al., 2017). The improper perception of the results of the manager’s decisions and the cost behavior in sales decline periods could lead to improper estimation in the systematic risk of companies and, therefore, the inappropriate allocation of resources in the financial markets (Park, 2017). During sales decline periods, the improper assessment of risk and efficiency of companies is more probable because of improper perception of investors regarding costs behavior