The effect of affiliated analysts on stock recommendations: Evidence from share pledges in China

We use the share pledge context in China to examine how affiliated analysts whose securities companies are pledgees of share pledge firms issue stock recommendations on these listed firms. We find that their recommendations are more optimistic than those of non-affiliated analysts, and they are more likely to issue Buy and Add recommendations, suggesting that they issue optimistic rating reports for share pledge firms due to their conflicts of interest. We also find a dynamic adjustment in the stock recommendation behavior of these analysts, and their probability after issuing optimistic stock recommendations is significantly reduced before and after the years that the affiliation relationship between them and share pledge firms both began and ended. These affiliated analysts continue to issue optimistic stock recommendations after visiting the share pledge firms if they work in the same location as the firms, or if they are star analysts among New Fortune’s “top five analysts,” and when the information transparency of the share pledge firms is higher. In addition, the optimistic stock recommendation behavior of affiliated analysts is more significant in our sample of firms with high share pledge ratios and downward stock price pressure. The earnings forecast quality of affiliated analysts is also found to be lower, and they are less inclined to downgrade stock recommendations for these share pledge firms. Buy recommendations issued by both non-affiliated and affiliated analysts can bring cumulative excess returns in the short event window, but those issued by affiliated analysts are significantly negative in the long-term event window, and significantly lower than those issued by non-affiliated analysts. Overall, our study shows that affiliated analysts issue optimistic rating reports on share pledge firms due to conflicts of interest, which leads to decision-making bias in investors and thus decreases the stock price crash risk of the firms. Our findings further reveal the economic consequences of share pledging and extend our understanding of the behavior of analysts in a conflict of interest situation from the share pledge perspective.     

Do brokerage houses add value? The market impact of UK sell-side analyst recommendation changes

This paper reports on the first full study investigating the economic role of sell-side analysts’ stock recommendations in the UK market. We also explore whether UK analysts are, in practice, influenced by the same biases as that reported for their US counterparts.We find that share prices are significantly influenced by analysts’ recommendation changes, not only at the time of the recommendation change but also in subsequent months. The price reaction to new sell recommendations is greater than the price reaction to new buy recommendations and exhibits post-recommendation drift which is consistent with initial underreaction to bad news. Returns generated are influenced, cross-sectionally, by factors associated with a firm's information environment and analyst incentives such as size, same-sign earnings forecast revisions and recommendation changes that skip a rank.We find that UK analysts’ investment recommendations in practice appear less susceptible to potential conflicts of interest than their US counterparts. The ratio of new sell to buy recommendations is higher in the UK and a greater proportion of such recommendations are accompanied by same-sign earnings forecast revisions than their equivalents in the US. We find brokerage house investment banking relationships do not appear to impact (adversely) on abnormal returns.     

The Accessibility and Perceived Usefulness of Information on the Capital Expenditure Intentions of UK Quoted Companies

This paper presents the results of two questionnaire surveys concerned with the accessibility and perceived usefulness of information relating to the capital expenditure plans of UK companies. The evidence presented indicates that such information is perceived as potentially useful for external investment purposes by analysts and by corporate financial managers. Moreover, it would appear that analysts do take steps to obtain such information. With regard to accessibility there would appear to be considerable cross-firm variation in the extent to which such information is made available to external investors. The findings also suggest that companies are more likely to disclose news about their capital expenditure intentions (a) when their finance directors perceive the information to be useful to external shareholders, (b) where there is an associated requirement to raise additional external finance, and (c) where the news relates to an increase, as opposed to a decrease, in capital expenditure. These findings are related to the literature on the economics of financial disclosure.     

Predictive gains to segmental disclosure matrices,geographic information and industry sector comparability

The aim of this study is to provide a detailed analysis of the multi-dimensional characteristics of segmental reporting, and their impact on improving investor-insight. We do this by examining the ability of segmental reporting characteristics among FTSE-100 firms to explain variation in the accuracy of analysts’ forecasts of earnings per share. We find that analyst-insight is significantly improved by the provision of data within a business-geographical matrix format, consistent with prior ‘laboratory’ evidence and UK analysts’ stated opinions in surveys. We also find that analyst-insight is improved where firms provide information regarding differences between their geographic markets and origins. In addition, analysts obtain improved insight from business segments that have a high degree of comparability to their respective industry sectors and where geographic segments are reported in a detailed manner.     

Dividend policy of German firms: A panel data analysis of partial adjustment models

German firms pay out a lower proportion of their cash flows, but a higher proportion of their published profits than UK and US firms. We estimate partial adjustment models and report two major findings. First, German firms base their dividend decisions on cash flows rather than published earnings as (i) published earnings do not correctly reflect performance because German firms retain parts of their earnings to build up legal reserves, (ii) German accounting is conservative, (iii) published earnings are subject to more smoothing than cash flows. Second, to the opposite of UK and US firms, German firms have more flexible dividend policies as they are willing to cut the dividend when profitability is only temporarily down.     

A re-examination of analysts’ superiority over time-series forecasts of annual earnings

We re-examine the widely held belief that analysts?? earnings per share (EPS) forecasts are superior to random walk (RW) time-series forecasts. We investigate whether analysts?? annual EPS forecasts are superior, and if so, under what conditions. Simple RW EPS forecasts are more accurate than analysts?? forecasts over longer horizons, for smaller or younger firms, and when analysts forecast negative or large changes in EPS. We also compare the accuracy of a third forecast of longer-term earnings based on a na?ve extrapolation of analysts?? 1-year-ahead forecasts. Surprisingly, this na?ve extrapolation provides the most accurate estimate of long-term (2- and 3-year-ahead) earnings. These findings recharacterize prior generalizations about the superiority of analysts?? forecasts and suggest that they are incomplete, misleading, or both. Moreover, in certain settings, researchers can rely on forecasts other than these explicit forecasts.     

THE ASSOCIATION BETWEEN ANALYSTS’ FORECAST REVISIONS AND EARNINGS COMPONENTS: THE EVIDENCE OF FRS 3

This study examines whether the earnings components as required by FRS 3 help UK analysts to predict firms’ earnings changes by investigating the statistical association between analysts’ forecast revisions and firms’ unexpected earnings components. I find that analysts’ forecast revisions made in different time horizons are consistently associated with unexpected earnings components as required by FRS 3. UK analysts are able to incorporate current-year unexpected earnings components into their current and future earnings forecasts even before firms officially release this information. However, empirical results also show that current-year unexpected earnings components are not fully incorporated into analysts’ forecasts of future earnings. Analysts appear to wait for more information releases regarding firms’ future earnings and delay their revisions of future earnings forecasts. This is consistent with the evidence that the cumulative revisions of current earnings forecasts are generally associated with prior-year unexpected earnings components, and the association appears to be stronger as time progresses. Overall, this study provides evidence suggesting that the earnings components as required by FRS 3 help UK analysts to identify firms’ permanent and transitory earnings changes over different forecast horizons. This study also provides strong evidence supporting the informativeness of earnings components for analysts’ forecasts and the information set perspective of FRS 3 that highlights the importance of earnings components in predicting a reporting entity’s future performance.     

Has the IASB Been Successful in Making Accounting Earnings More Useful for Prediction and Valuation? UK Evidence

When producing International Financial Reporting Standards (IFRS), one of the main goals of the International Accounting Standards Board (IASB) was to create a set of standards which were more useful to investors as a predictive tool. We assess the success of the IASB in achieving this goal by investigating the effects of the introduction of IFRS on the relative information content of reported earnings and forecasted earnings under UK generally accepted accounting practices (GAAP) and IFRS. Results indicate that the value relevance of forecasted earnings is significantly lower under IFRS while the value relevance of reported earnings is significantly larger. These findings suggest that IFRS substitutes price‐relevant information previously provided to the market in the form of analyst forecasts with information encoded by companies in their reported earnings. This implies that the IASB was indeed successful in its stated goal and points towards IFRS forecasts being more accurate and less dispersed than UK GAAP forecasts. This, in turn, implies that analysts are able to provide more informative forecasts under IFRS than under pre‐IFRS regimes and that the aforementioned substitution effect is not a consequence of any decrease in the quality of forecasts under the new regime.     

Interlock Concentration and Analyst Forecast Accuracy: Value Implications of Interlock

From the perspective of information commonalities among firms with director interlock relationships, this study mainly investigates the outcomes of earnings forecasts by analysts who choose to concentrate on interlocked firms (analysts following both a firm and its interlocked partner firm in their research portfolio). Using interlocked A‐share firms listed in the Chinese Shanghai and Shenzhen Stock Exchanges from 2008 to 2013 as samples, we empirically find that analysts who concentrate on interlocked firms produce more accurate earnings forecasts than analysts who do not. In additional analysis, we also find that analysts with an interlock concentration provide superior earnings forecast quality for other non‐interlocked firms in their research portfolios. Finally, through examining the market reaction to interlocked firms, we find that analysts with an interlock concentration provide new information and improve information efficiency for the capital market.     

Do German security analysts herd?

We employ an innovative methodology suggested by Bernhardt et al. (J. Financ. Econ. 80:657–675, 2006) to examine the herding (or anti-herding) behavior of German analysts regarding earnings forecasts. This methodology avoids well-known shortcomings often encountered in related studies, such as correlated information signals, unexpected common shocks to earnings, systematic optimism or pessimism, or forecast target mismeasurement. Our findings suggest that German analysts anti-herd, that is, they systematically issue earnings forecasts that are further away from the consensus forecast than their private information indicates. Furthermore, we analyze the association between herding behavior and different characteristics, including the size of the brokerage, general or firm-specific experience, and the coverage of firms on the Neuer Markt. We mainly confirm findings for the United States, for example, that anti-herding is more severe in cases of higher competition among analysts. Contrary to anecdotal evidence, we also find anti-herding behavior in earnings forecasts for Neuer Markt firms during the “new economy” bubble.

Do UK Security Analysts Over-react?

Consensus analysts' earnings per share forecasts have become increasingly accessible in recent years and such measures have been widely adopted by academics as proxies for the market's expectations of earnings. Some US studies have suggested that analysts, in revising earnings forecasts, are prone to over-reaction. This study tests for evidence of over-reaction in revisions of the consensus earnings per share forecasts of UK companies reported by the Institutional Brokers Estimate System. For a series of periods, portfolios of companies attracting high and low revisions of earnings forecasts are constructed. We then compare the subsequent earnings forecast of the companies which attracted high revisions in the portfolio formation period with those of the companies which attracted low revisions in the portfolio formation period. We also compare actual changes in annual earnings with forecast changes in annual earnings. Both analyses suggest that UK analysts are prone to under-reaction, a finding which contrasts with the US studies which have identified over-reaction. There is little evidence that the market, in reacting to earnings forecast revisions, fails to recognise this under-reaction.     

The Effect of CEO Extraversion on Analyst Forecasts: Stereotypes and Similarity Bias

In an experiment with professional analysts, we study their reliance on CEO personality information when producing financial forecasts. Drawing on social cognition research, we suggest analysts apply a stereotyping heuristic, believing that extraverted CEOs are more successful. The between‐subjects results with CEO extraversion as treatment variable confirm that analysts issue more favorable forecasts (earnings per share, long‐term earnings growth, and target price) for firms led by extraverted CEOs. Increased forecast uncertainty leads to even stronger stereotyping. Additionally, personality similarity between analysts and CEOs has a large effect on financial forecasts. Analysts issue more positive forecasts for CEOs similar to themselves.     

The Relationship between Earnings,Funds Flows and Cash Flows: Evidence for the UK

Recent UK information content studies have provided evidence of a significant relationship between earnings and share prices, as in the US, but have also identified an apparent lack of information content for operating cash flow, which is in marked contrast to findings from US research. This paper provides direct evidence on the relationship between earnings, funds flows and cash flows in the UK during the period 1965–84, using tests of association and predictive tests based on a research methodology applied by Bowen, Burgstahler and Daley (1986) to US data. The results provide UK evidence on the contemporaneous and predictive relationships between measures of earnings, funds flows and cash flows which are generally consistent with the US findings of Bowen et al. and which do not support the view that earnings in the UK are superior to cash flows as predictors of future cash flows.     

A Comparative Analysis of Auditor, Manager and Financial Analyst Interpretations of SFAS 5 Disclosure Guidelines

This study examines empirically whether financial analysts (users), as well as managers (preparers) and external auditors ascribe different interpretations to the SFAS 5 disclosure criteria. We find: (1) financial analysts are, on average, more conservative than managers and auditors in their numerical interpretations of both the 'remote' and 'probable' verbal phrases; (2) managers and auditors share very similar numerical interpretations of these verbal phrases; (3) audit partners' numerical interpretations of the 'remote' region are between those of managers and users, whereas audit managers align their numerical interpretations with those of managers. One danger is that preparers of financial statements may omit loss contingency information that users consider valuable.     

Are All Security Analysts Equal?

We examine the extent to which security analysts are homogeneous in their effect on firm valuation as measured by Tobin's Q. Earlier research documents a significant and positive relation between analyst coverage and firm valuation. We identify three classes of equity analysts and examine their differential effect on firm valuation associated with their coverage and their information production. We find that equity analysts are not homogeneous in their effect on firm valuation. The presence of analysts at national securities firms have the strongest effect on firm valuation followed by analysts at regional securities firms and finally analysts at nonbrokerage, or research, firms. We attribute this result to the differential monitoring and information dissemination function rendered by the analysts. Information produced by analysts, however, does not share the same credibility. Specifically, we find brokerage firms' buy recommendations are discounted by the market and have a weak effect on firm valuation. The results can be supported by arguments that brokerage firm analysts' recommendations are contaminated by their firms' investment banking relations with corporations.     

Stock Prices and the Supply of Information

We develop a model in which the dependence of the brokerage commission rate on share price provides an incentive for brokers to produce research reports on firms with low share prices. Stock splits therefore affect the attention paid to a firm by investment analysts. Managers with favorable private information about their firms have an incentive to split their firm's shares in order to reveal the information to investors. We find empirical evidence that is consistent with the major new prediction of the model, that the number of analysts following a firm is inversely related to its share price.     

Conflicts of Interest and Research Quality of Affiliated Analysts in the German Universal Banking System: Evidence from IPO Underwriting

The quality of equity research by financial analysts is a prerequisite for an efficient capital market. This study investigates the quality of earnings forecasts and stock recommendations for initial public offerings (IPOs) in Germany. The empirical study includes 12,605 earnings forecasts and 6,209 stock recommendations of individual analysts for the time period from 1997 to 2004. The focus of this study is on analysing the potential conflicts of interest that arise when the analyst is affiliated with the underwriter of an IPO. In a universal banking system these conflicts of interest are usually more pronounced and therefore interesting to investigate. The empirical findings for the German financial market suggest that earnings forecasts and stock recommendations of the analysts belonging to the lead-underwriter are on average inaccurate and biased, indicating some conflicts of interest. Moreover, the stock recommendations of the analysts that are affiliated with the lead-underwriter are often too optimistic resulting in a significant long-run underperformance for the investor. In contrast, unaffiliated analysts provide better earnings forecasts and stock recommendations that result in a superior performance for the investor.     

An analyst by any other surname: Surname favorability and market reaction to analyst forecasts

We find that forecast revisions by analysts with more favorable surnames elicit stronger market reactions. The effect is stronger among firms with lower institutional ownership and for analysts with non-American first names. Following the 9/11 terrorist attacks, and France and Germany's opposition to the Iraq War, revisions by analysts with Middle Eastern and French or German surnames, respectively, generated weaker market reaction. Surname favorability is not associated with forecast quality, but it has complementary effects with forecast performance on analysts’ career outcomes. Surname favorability mitigates under-reaction to forecast revisions. These findings are distinct from the effects of ethnic, cultural proximity, or in-group bias.     

Investor protection and analysts’ cash flow forecasts around the world

We find that analysts are more likely to provide cash flow forecasts in countries with weak investor protection. This finding is consistent with our hypothesis that market participants demand (and analysts supply) cash flow information when weak investor protection results in earnings that are less likely to reflect underlying economic performance. Our results suggest that information intermediaries respond to market-based incentives to attenuate the adverse effects of country-level institutional factors on earnings’ usefulness. These findings contribute to the literature by shedding light on the institutional determinants of analysts’ research activities, and on the nature of the financial information they generate.     

An Analysis of Brokers' and Analysts' Unpublished Forecasts of UK Stock Returns

This paper describes an empirical study of over 4000 specific share return forecasts made by 35 UK stockbrokers and by the internal analysts of a large UK investment institution. A comparison of forecast and realised returns reveals a small but potentially useful degree of forecasting ability. A large part of the information content of the forecasts, however, appears to be discounted in the market place within the first month. Nevertheless, an analysis of some 3000 transactions motivated by, and executed at the time of, the forecasts shows that the apparent predictive ability of the recommendations could be translated into superior performance by the fund's investment managers. Differences in forecasting ability between brokers do not appear to persist over time, but predictive accuracy can be improved by pooling simultaneous forecasts from different sources.