As CEOs near retirement, they get more optimistic about corporate earnings, raising questions about the validity of earnings forecasts and whether they may be driven by attempts to inflate stock prices, according to new academic research.

In a recent study published by the American Accounting Association, three accounting professors find that CEOs in their final year before retirement are more likely to issue forecasts of future earnings, and to issue those forecast more frequently, than in the years leading up to the final year. The study says predictions erring on the side of optimism produce a bias that is 2-1/2 times greater than forecasts might otherwise look. The authors say incentives to beef up forecasts grow with the size of the CEO's stock and option holdings because the value of those holdings would appreciate as share price increases.

The authors -- Shawn X. Huang of Arizona State University, Cory A. Cassell of the University of Arkansas, and Juan Manuel Sanchez of Texas Tech University -- studied 862 retirements from 1997 through 2009, studying forecasts before retirement and results following the CEO's departure. The analysis revealed 35 percent of soon-to-retire CEOs issued at least one forecast in their final year compared to only 20 percent in preceding years. 

The analysis also found about two-thirds of forecasts issued by soon-to-retire CEOs sparked an above-market return on the company's stock in the three days following the CEO's prediction, but only half of those forecasts produced the same result in preceding years. The upward bias is measured as overestimating earnings from 0.2 percent of share price to 0.5 percent, the study says.

The authors say roughly 70 percent of CEO retirements were announced as much as 80 days before the event occurred, so investors should take note of forecasts made by CEOs whose retirements have already been announced. The authors also suggest the Securities and Exchange Commission should consider new rules to address the concern. “Because SEC trading rules related to CEOs' post-retirement security transactions are less stringent than those in effect during their tenure with the firm, post-retirement transactions can be made before the earnings associated with the opportunistic forecast are realized and with reduced regulatory scrutiny," the study says.