Chaebol-affiliated analysts: Conflicts of interest and market responses

Some Korean business groups, or chaebols, have a large stake in securities firms that issue analysts’ reports on their member companies. This structure is unique in that industrial companies and securities firms are affiliated and operate within the same group. We investigate the informational content of earnings forecasts, stock recommendations and target prices made by the chaebol-affiliated analysts, using data collected between 2000 and 2008. The chaebol analysts tend to make more optimistic earnings forecasts for the member companies. The mean EPS forecast error (5.36%) of the affiliated analysts for the same chaebol company are significantly larger than that (3.23%) of other chaebol and independent analysts. The chaebol analysts also assign better recommendations by almost one level and set target prices 2.5% higher to the member companies after controlling for company and analyst characteristics. These results are consistent with the hypothesis that chaebol analysts’ reports are biased by conflicts of interest. Stock market reactions do not differ in response to announcements of stock recommendations issued by affiliated vs. non-affiliated analysts. This suggests that capital markets do not recognize the conflicts of interest inherent in chaebol analysts’ reports.     

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.     

Underwriting Relationships and Analyst Independence in Europe

This paper examines the accuracy of security analysts’ earnings forecasts and stock recommendations for firms in 13 European countries. We document at least three key findings. First, we find strong evidence that lead and co‐lead underwriter analysts’ earnings estimates and stock recommendations are significantly more optimistic than those provided by unaffiliated analysts. Second, we find that lead and co‐lead underwriter analysts’ earnings forecast and stock recommendations are significantly more optimistic for underwriter stocks than for those they provide for other stocks. Third, we also find evidence that these biases found within earnings forecasts and stock recommendations are not driven by one particular country. In short, these findings suggest that affiliated analysts are more optimistic perhaps to maintain investment banking relations.     

The Value Relevance of Management Forecasts and Their Impact on Analysts' Forecasts: Empirical Evidence From Japan

A major financial disclosure feature in Japan is that stock exchanges require firms to provide next year's earnings forecasts. This study investigates the value relevance of Japanese management earnings forecasts and their impact on analysts' earnings forecasts. First, the value relevance of management forecasts is investigated using a valuation framework provided by Ohlson (2001 ), in which firm value is expressed as a function of book value, current earnings and next year's expected earnings. The analysis yields that of the three accounting variables examined, management forecasts have the highest correlation and incremental explanatory power with stock price.
Next, the impact of management forecasts on analysts' forecasts is examined. The results show that more than 90% of changes in analysts' forecasts are explained by management forecasts alone. Further analysis reveals that the heavy dependence of financial analysts on management forecasts in formulating their own forecasts may partially be attributed to the relatively high accuracy of management forecasts. At the same time, financial analysts also somewhat modify management forecasts when certain financial factors indicate that the credibility of management forecasts is in doubt.
Overall, this study presents empirical evidence that Japanese management forecasts provide useful information for the market and have a significant influence on analysts' forecasts.     

Tests of Market Reaction and Analysts' Forecast Revisions to the Disclosure of Improved Management Earnings Expectations: A Case of Concurrent Bad News Management Earnings Forecasts

This paper tests whether a negative stock market reaction, associated with a management forecast of near term bad earnings, is lessened by a concurrent management forecast of improved longer term earnings expectations. Stock market reactions depend on the creditability of management forecasts of improved earnings expectations. In this analysis, the authors examined market reactions around the time of management forecasts of bad earnings, with and without longer-term management forecasts of improved earnings expectations. The results show that the stock market reaction is significantly less negative when management forecasts of bad earnings are followed by management forecasts of improved long run earnings expectations than when management forecasts of bad earnings are not accompanied by management forecasts of improved earnings expectations. In addition, this paper examines financial analysts' reactions to management bad earnings forecasts and management forecasts of improved earnings expectations. The findings show that analysts react less negatively to management forecasts of improved earnings expectations than to management forecasts of bad earnings. An analysis of a sub-sample of observations shows that analysts consider management forecasts of improved earnings expectations to imply improved expected future performance, thus conveying that analysts give credence to management forecasts of improved earnings expectations. However, results show that the stock market and analysts are unable to distinguish management forecasts of improved earnings expectations that come true from management forecasts of improved earning expectations that do not come true.     

Inside the “Black Box” of Sell‐Side Financial Analysts

Our objective is to penetrate the “black box” of sell‐side financial analysts by providing new insights into the inputs analysts use and the incentives they face. We survey 365 analysts and conduct 18 follow‐up interviews covering a wide range of topics, including the inputs to analysts’ earnings forecasts and stock recommendations, the value of their industry knowledge, the determinants of their compensation, the career benefits of Institutional Investor All‐Star status, and the factors they consider indicative of high‐quality earnings. One important finding is that private communication with management is a more useful input to analysts’ earnings forecasts and stock recommendations than their own primary research, recent earnings performance, and recent 10‐K and 10‐Q reports. Another notable finding is that issuing earnings forecasts and stock recommendations that are well below the consensus often leads to an increase in analysts’ credibility with their investing clients. We conduct cross‐sectional analyses that highlight the impact of analyst and brokerage characteristics on analysts’ inputs and incentives. Our findings are relevant to investors, managers, analysts, and academic researchers.     

Measure for Measure: The Relation between Forecast Accuracy and Recommendation Profitability of Analysts

We examine the contemporaneous relation between earnings forecast accuracy and recommendation profitability to assess the effectiveness with which analysts translate forecasts into profitable recommendations. We find that, after controlling for expertise, more accurate analysts make more profitable recommendations, albeit only for firms with value‐relevant earnings. Next, we show that conflicts of interest from investment banking activities affect the relation between accuracy and profitability. In the case of buy recommendations, more accurate forecasts are associated with more profitable recommendations only for the nonconflicted analysts. For hold recommendations, higher levels of accuracy are associated with higher levels of profitability for conflicted analysts, provided these recommendations are treated as sells. Finally, we find that regulatory reforms aimed at mitigating analyst conflicts of interest appear to have improved the relation between accuracy and profitability. Specifically, the integrity of buy and hold recommendations has improved and the change is more pronounced for analysts expected to be most conflicted.     

财务分析师盈利预测的投资价值:来自深沪A股市场的证据

本文研究了中国股票市场上财务分析师的盈利预测信息对投资者是否有价值。我们发现,可以利用公开的盈利预测制定可获利的套头交易策略。套头交易的回报率不仅在统计意义上显著大于零,而且在经济意义上也是显著的。这些结果不受不同的检验方法影响,也无法为我们所考虑到的风险因素所解释。本文的发现说明了中国的股票市场尚未达到Fama(1970)意义上的半强式有效,投资者在投资决策时可以利用分析师的盈利预测以提高其投资的回报。此外,本文的结果也有助于回答中国的财务分析师是否具有专业胜任能力这一颇有争议的问题。     

Do investor expectations affect sell-side analysts’ forecast bias and forecast accuracy?

We examine the association between investor expectations and its components and sell-side analysts’ short-run quarterly earnings forecast bias and forecast accuracy. To measure investor expectations, we use the Index of Consumer Expectations survey and decompose it into the “fundamental” component related to underlying economic factors (FUND) and the “sentiment” component unrelated to underlying economic factors (SENT). We find that analysts are the most optimistic and the least accurate when SENT is higher. Management long-horizon earnings forecasts attenuate the effects of SENT on forecast optimism and forecast accuracy. Analysts are also the most accurate when FUND is higher. Last, the market places more weight on unexpected earnings when SENT is high. These findings suggest that analysts are affected by investor sentiment and the market reacts more strongly to unexpected earnings when analyst forecasts are the least accurate. The last result potentially explains why prior research (for example, Baker and Wurgler, The Journal of Finance 61:1645–1680, 2006) finds an association between investor sentiment and cross-sectional stock returns.     

Do accurate earnings forecasts facilitate superior investment recommendations?

We find that analysts who issue more accurate earnings forecasts also issue more profitable stock recommendations. The average factor-adjusted return associated with the recommendations of analysts in the highest accuracy quintile exceeds the corresponding return for analysts in the lowest accuracy quintile by 1.27% per month. Our findings provide indirect empirical support for valuation models in the accounting and finance literatures (e.g., Ohlson, 1995) that emphasize the role of future earnings in predicting stock price movements. Our results also suggest that imperfectly efficient markets reward information gatherers, such as security analysts, for their costly activities in generating superior earnings forecasts.     

Underlying risk preferences and analyst risk-taking behavior

We investigate the relationship between underlying risk preferences on analysts’ work-related decisions. Specifically, we examine whether facial width-to-height ratio (fWHR), an innate personal characteristic that has been linked to financial risk tolerance, is associated with analysts’ stock coverage decisions and the boldness of their earnings forecasts and stock recommendations. We find that high-fWHR analysts cover firms with lower earnings predictability, and issue bolder forecasts and recommendations. Our findings shed new light on the black box of analyst decision making, assisting investment practitioners in evaluating the information content produced by different types of analysts and understanding the observed dispersion in analyst forecasts.     

Do analysts who understand accounting conservatism exhibit better forecasting performance?

This study investigates the performance of analysts when they match the asymmetric timeliness of their earnings forecast revisions (i.e., asymmetric forecast timeliness) with the asymmetric timeliness of firms’ reported earnings (i.e., asymmetric earnings timeliness). We find that better timeliness‐matching analysts produce more accurate earnings forecasts and elicit stronger market reactions to their forecast revisions. Further, better timeliness‐matching analysts issue less biased earnings forecasts, more profitable stock recommendations and have more favorable career outcomes. Overall, our results indicate that analysts’ ability to incorporate conditional conservatism into their earnings forecasts is an important reflection of analyst expertise and professional success.     

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.     

Financial analysts' forecasts of earnings: A better surrogate for market expectations

The specification of the market expectation of accounting numbers is a common feature of many empirical studies in accounting and finance. Givoly and Lakonishok (1979) found that financial analysts' forecasts have information content. This study evaluates the quality of analysts' forecasts as surrogates for the market expectation of earnings and compares it with that of prediction models commonly used in research. Results indicate that prediction errors of analysts are more closely associated with security price movements, suggesting that analysts' forecasts provide a better surrogate for market expectations than forecasts generated by time-series models. The study also identifies factors that might contribute to the performance of the financial analysts'forecasts. The broadness of the information set employed by analysts and, to a lesser extent, their reliance on information released after the end of the fiscal year appear to be important contributors to their performance.     

证券分析师VS统计模型:证券分析师盈余预测的相对准确性及其决定因素

本文使用2005年35家券商对我国上市公司做出的每股盈余预测数据,考察了证券分析师盈余预测相对于统计模型的相对准确性及其决定因素。我们发现,我国证券分析师做出的盈余预测,同以年度历史数据为基础的统计模型得出的盈余预测相比,预测误差较小,证券分析师盈余预测具有一定的优势;但同某些以季度历史数据为基础的统计模型得出的盈余预测相比,预测误差较大,证券分析师盈余预测不具有优势。我们同时考察了决定证券分析师盈余预测相对准确性的决定因素。我们发现,公司每股盈余的波动性越大,公司上市越晚,跟踪公司的分析师越多,证券分析师的优势就越大。我们的研究对证券分析师以及投资者都有一定的启示作用。     

Increased market response to earnings announcements in the 21st century: An Empirical Investigation

We examine the role of concurrent information in the striking increase in investor response to earnings announcements from 2001 to 2016, as measured by return variability and volume following Beaver (1968). We find management guidance, analyst forecasts, and disaggregated financial statement line items are more frequently bundled with earnings announcements, and each of these items explains part of the increase in market response. Furthermore, collectively, these concurrent information releases explain a substantial fraction of the increase in market response to earnings announcements since 2001. This is in contrast to the decline in market response to management guidance issued separately from earnings and the much smaller increase in market response to analyst forecasts issued separately from earnings over this time. The findings indicate that information arrival at earnings announcement dates has increased significantly over the past two decades, and that key components of this are increased disclosures by management of guidance and financial statement line items and forecasts by analysts.     

Analysts' Forecasts: Low-Balling,Market Efficiency,and Insider Trading

The phenomenon of low-balling reported in the financial press involves downward biased projections of earnings by managers or analysts, thereby artificially lowering market expectations and creating a positive earnings surprise when actual earnings are announced. This study reports that the stock market does respond to such surprises relative to analysts' reported forecasts. Further, the proportion of insider buy-transactions in the period prior to the earnings forecast is significantly higher for the sample with high positive earnings surprise than for the control sample with zero forecast errors. The study cannot distinguish whether managers or analysts are the source of the low-balling and therefore makes no statement on the legality of such insider trades.     

Political contributions and analyst behavior

We show that the personal traits of analysts, as revealed by their political donations, influence their forecasting behavior and stock prices. Analysts who contribute primarily to the Republican Party adopt a more conservative forecasting style. Their earnings forecast revisions are less likely to deviate from the forecasts of other analysts and are less likely to be bold. Their stock recommendations also contain more modest upgrades and downgrades. Overall, these analysts produce better quality research, which is recognized and rewarded by their employers, institutional investors, and the media. Stock market participants, however, do not fully recognize their superior ability as the market reaction following revisions by these analysts is weaker.     

Analysts’ Earnings Forecasts for DAX100 Firms During the Stock Market Boom of the 1990s

This paper examines the reliability of financial analysts’ consensus earnings forecasts in the 1990s. Analysts are often accused of having fuelled the stock market boom with exaggerated evaluations of firms’ prospects. However, this criticism primarily refers to the analysts’ buy recommendations rather than earnings forecasts. Although biases in earnings forecasts have been reported since the 1980s, a systematic study capturing the period of ‘irrational exuberance’ until 2000 on the German stock market has not yet been published. Our data set consists of DAX100 firms, leaving out the peculiarities of forecasting earnings (or rather losses) of young technology firms. To evaluate the information content of analysts’ forecasts, we confront them with five alternative forecasting models. The empirical results reveal that analysts’ forecasts were too optimistic throughout the entire sample period. However, contrary to the increase in stock prices, the optimistic bias has declined over time. If the bias is removed, the analysts’ consensus forecasts significantly outperform all other models considered. Thus, the forecasts seem to be informative with respect to earnings differences, even if the market level of earnings is optimistically overstated.     

Inflation,earnings forecasts,and post-earnings announcement drift

We examine whether financial analysts fully incorporate expected inflation in their earnings forecasts for individual stocks. We find that expected inflation proxies, such as lagged inflation and inflation forecasts from the Michigan Survey of Consumers, predict the future earnings change of a portfolio long in high inflation exposure firms and short in low or negative inflation exposure firms, but analysts do not fully adjust for this relation. Analysts’ earnings forecast errors can be predicted using expected inflation proxies, and these systematic forecast errors are related to future stock returns. Overall, our evidence is consistent with the Chordia and Shivakumar (J Account Res 43(4):521–556, 2005) hypothesis that the post-earnings announcement drift is related to investor underestimation of the impact of expected inflation on future earnings change.