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.     

衍生工具应用能改善资本市场信息环境吗？——基于分析师预测行为的视角

本文通过文本搜索获得企业衍生工具运用情况,在此基础上研究了企业衍生工具应用对分析师跟踪和预测信息结构的影响,并且进一步区分了明星分析师和非明星分析师预测行为的差异。研究结果表明,企业运用衍生工具会导致分析师跟踪数量显著减少,公共信息精度下降,从而对资本市场信息环境产生负面影响。但是,进一步我们发现分析师跟踪数量的减少和公共信息精度的下降是由非明星分析师所致,明星分析师跟踪数量和公共信息精度没有显著变化,私有信息精度反而增加;而非明星分析师跟踪数量显著减少,公共信息精度明显下降。本文的结论有助于我们进一步理解衍生工具应用对资本市场信息环境的影响,以及分析师在信息传递中的作用机制。     

Is Working Capital Information Useful for Financial Analysts? Evidence from China

Financial analysts are important information intermediaries in the capital market. This study investigates whether information about working capital management is useful for financial analysts of Chinese firms. With a sample of listed companies from 2004 to 2014, we find that the efficiency of working capital management is positively associated with the number of analyst following and analyst forecast accuracy, and negatively associated with analyst forecast dispersion. Specifically, when the cash conversion cycle becomes longer, number of analyst following and the accuracy of their mean forecasts decrease, while the forecast dispersion increases. The findings of this study indicate a potential mechanism through which information about working capital management is incorporated in stock price in emerging markets such as China.     

Does Regulation FD work? Evidence from analysts' reliance on public disclosure

We examine how Regulation FD changed analysts' reliance on firms' public disclosure. Regulation FD is associated with a stronger analyst response to earnings announcements, management forecasts and conference calls—that is, analysts respond to these events more quickly, more frequently and with larger forecast revisions after FD. Further, following public disclosure, the decline in analyst forecast dispersion and forecast error accelerates after FD. We find no such changes either for foreign ADR firms or around several confounding events. Overall, Regulation FD levels the playing field between the analysts and individual investors, thereby promoting “fair game” property of the market.     

Seeing is believing: analysts’ corporate site visits

This study examines the impact of corporate site visits on analysts’ forecast accuracy based on a sample of such visits to Chinese listed firms during 2009–2012. We find that analysts who conduct visits (“visiting analysts”) have a greater increase in forecast accuracy than other analysts. Consistent with the notion that site visits facilitate analysts’ information acquisition through observing firms’ operations, we find that the results are stronger for manufacturing firms, firms with more tangible assets, and firms with more concentrated business lines. Moreover, we find that the effect of a site visit is greater when the site visit is an analyst-only visit, when the current visit is preceded by fewer visits, and when visiting analysts are based far from the visited firms. Furthermore, we find that site visits partially mitigate nonlocal analysts’ information disadvantage. Collectively, these results indicate that site visits are an important information acquisition activity for analysts.     

Adopting a Label: Heterogeneity in the Economic Consequences Around IAS/IFRS Adoptions

This study examines liquidity and cost of capital effects around voluntary and mandatory IAS/IFRS adoptions. In contrast to prior work, we focus on the firm‐level heterogeneity in the economic consequences, recognizing that firms have considerable discretion in how they implement the new standards. Some firms may make very few changes and adopt IAS/IFRS more in name, while for others the change in standards could be part of a strategy to increase their commitment to transparency. To test these predictions, we classify firms into “label” and “serious” adopters using firm‐level changes in reporting incentives, actual reporting behavior, and the external reporting environment around the switch to IAS/IFRS. We analyze whether capital‐market effects are different across “serious” and “label” firms. While on average liquidity and cost of capital often do not change around voluntary IAS/IFRS adoptions, we find considerable heterogeneity: “Serious” adoptions are associated with an increase in liquidity and a decline in cost of capital, whereas “label” adoptions are not. We obtain similar results when classifying firms around mandatory IFRS adoption. Our findings imply that we have to exercise caution when interpreting capital‐market effects around IAS/IFRS adoption as they also reflect changes in reporting incentives or in firms’ broader reporting strategies, and not just the standards.     

Stock index adjustments and analysts’ forecast optimism: A quasi-natural experiment on the CSI 300 Index

As stock index adjustments comprise a basic system of capital market, their potential influence on analysts’ earnings forecasts is worthy of research. Based on a research sample of 23 adjustments to the CSI 300 Index from June 2007 to June 2018 and the backup stocks announced during the same period, this study examines the impact of additions to stock index on analysts’ forecast optimism using a staggered difference-in-differences model. The research results show that after stocks are added to the stock index, analysts’ earnings forecast optimism about these stocks increases significantly. Cross-sectional analysis indicates that this increase is more significant when the market is bullish, institutional ownership is low, the ratio of listed brokerage firms is low, star analyst coverage is low, firms show seasoned equity offering activity, the ratio of analysts from the top five brokerage firms ranked by commission income is high, and the analysts’ brokerage firms are shareholders. However, analyst-level tests find that analysts’ ability helps to reduce the impact of additions to stock index on earnings forecast optimism. Furthermore, additions to stock index significantly increase analyst coverage and forecast divergence. Economic consequences tests find additions to stock index significantly increases stock price synchronization, which is partly mediated by analysts’ earnings forecast optimism. This study enriches the literature on the impact of basic capital market systems and analyst behavior. The findings suggest that investors should rationally evaluate analysts’ earnings forecasts for stocks added to the stock index and obtain further information from various channels to improve asset allocation efficiency.     

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.     

Capital raising in the offshore market

US corporations can raise capital in the offshore market using Regulation S, adopted by the Securities and Exchange Commission (SEC) in 1990 and modified in 1996. We examine how offshore offerings are done under Regulation S, what types of companies use this market, the discount companies offer investors to compensate for illiquidity in the market, and the impact of the new disclosure requirements on capital raising in the offshore market. We find that small firms tend to raise capital in this market. During our sample period before the 1996 rule change the median market capitalization of reporting firms was $16.82 million with a median stock price of $1.13. The mean and median discount offered to foreign investors was 32.84% and 40.53%, respectively. Offerings during this period resulted in average share dilution of 11.97%. We find that before the disclosure requirements, firms were “gaming the system” by giving foreign investors just enough time to resell the securities back into the United States before the initial sale became public information. After the rule changes, Regulation S offerings are not perceived to be “shady”, and larger firms are now using the market, resulting in lower average discount and dilution.     

CDS trading and analyst optimism

This paper investigates whether and how the initiation of Credit Default Swaps (CDS) trading affects analyst forecast optimism. First, we document that the initiation of CDS trading curbs analyst forecasts optimism. Second, we find that the dampening effect of CDS on analyst optimism is stronger for firms with negative news and for firms with poorer financial performance or higher leverage, supporting a “correction effect” of CDS on non-strategic optimism. Moreover, we find that CDS also has a “disciplining effect” on strategic optimism that arises from incentives to cultivate relation with management or to please institutional investors. Overall, our evidence shows that the CDS market not only provides important information for analysts, but also alters analysts’ reporting incentives and enhances their objectivity. Additional analysis shows that this effect has disappeared after the Dodd-Frank Act.     

IFRS adoption and analysts’ earnings forecasts: Australian evidence

We study 145 large listed Australian firms to explore the impact of international financial reporting standards (IFRS) adoption on the properties of analysts’ forecasts and the role of firm disclosure about IFRS impact. We find that analyst forecast accuracy improves, and there is no significant change in dispersion in the adoption year, suggesting that analysts coped effectively with transition to IFRS. However, we do not observe the expected relationship between firms’ IFRS impact disclosures in their financial statements issued at the end of the transition year with forecast error and dispersion in the adoption year. The results question the timeliness and usefulness of financial statement disclosure, even in a setting where disclosure was mandated by accounting standards (AASB 1047 and AASB 1) and firms had strong incentives to provide information to analysts.     

Do accounting standards matter to financial analysts? An empirical analysis of the effect of cross-listing from different accounting standards regimes on analyst following and forecast error

This paper explores whether the effects of cross-listing on analyst following and forecast error differ among firms with different accounting standards. The results reveal a higher increase in the number of analysts for cross-listed firms that follow their home country's GAAP prior to cross-listing and reconcile or switch to IAS/US GAAP or UK GAAP after cross-listing, compared to those that adopt IAS or US GAAP prior to cross-listing. We find that firms that switch to IAS/US GAAP have a higher increase in analyst following after cross-listing compared to firms that reconcile to IAS/US GAAP. In addition, we find a higher increase in analyst following after cross-listing for firms from low-level accounting standards environments compared to firms from high-level accounting standards environments. Our results show evidence of an increase in the magnitude of analysts’ forecast error after cross-listing for firms that follow their home country's GAAP pre-cross-listing but reconcile post-cross-listing to IAS/US GAAP or UK GAAP. On the other hand, we report a decrease in forecast error for firms that switch to IAS/US GAAP.     

Environmental performance and analyst information processing costs

This study tests whether the information processing costs of analysts vary positively with the environmental performance information available on the firms they follow. Consistent with this conjecture, we find that these costs increase when analysts process a wider array of environmental performance ratings. Specifically we find that as the number of environmental performance ratings increases, analysts cover fewer firms in their portfolio, provide fewer earnings-per-share (EPS) forecast revisions, and make less timely forecast revisions. Two additional tests confirm that our results relate to environmental performance information and not to confounding factors. First, the “shock” of the Global Warming Solutions Act of 2006 implemented for California firms in 2012 increases analyst information processing costs incremental to the main effect of environmental performance ratings. Second, analyst information processing costs increase further in the year a firm covered by an analyst provides a CSR report for the first time. Our results have implications for firm managers considering voluntary environmental disclosure and investors deciding on what stocks to include in their socially responsible portfolios because when processing costs are high, analysts will provide less information or less timely information, resulting in more gradual price discovery in capital markets.     

Domestic Accounting Standards, International Accounting Standards, and the Predictability of Earnings

We investigate (1) whether the variation in accounting standards across national boundaries relative to International Accounting Standards (IAS) has an impact on the ability of financial analysts to forecast non-U.S. firms' earnings accurately, and (2) whether analyst forecast accuracy changes after firms adopt IAS. IAS are a set of financial reporting policies that typically require increased disclosure and restrict management's choices of measurement methods relative to the accounting standards of our sample firms' countries of domicile. We develop indexes of differences in countries' accounting disclosure and measurement policies relative to IAS, and document that greater differences in accounting standards relative to IAS are significantly and positively associated with the absolute value of analyst earnings forecast errors. Further, we show that analyst forecast accuracy improves after firms adopt IAS. More specifically, after controlling for changes in the market value of equity, changes in analyst following, and changes in the number of news reports, we find that the convergence in firms' accounting policies brought about by adopting IAS is positively associated with the reduction in analyst forecast errors.     

Performance commitments and the properties of analyst earnings forecasts: Evidence from Chinese reverse merger firms

We investigate whether the performance commitments in Chinese reverse merger (RM) transactions affect the properties of analyst earnings forecasts. All RM firms in China are required to make performance commitments for a limited number of years after being publicly listed. As performance commitment is an important piece of public information, it can influence analysts' understanding of firms and their efforts to forecast earnings. Using manually assembled information on RM transactions, we find that, in comparison to the control firms, RM firms exhibit an increase in analyst forecast error and dispersion after the end of performance commitment. This effect is more pronounced in firms with lower levels of information transparency. We also document that the public information contents of analyst forecasts decrease and forecast revisions increase in the post-commitment period, while the private information content of analyst forecasts and the number of their firm visits remain unchanged. Overall, our findings suggest that analysts rely greatly on public information; they have important implications for academics and policymakers in understanding how performance commitments in RM transactions affect the market information environment.     

Does the classification of intangibles matter? An equivalence testing

Many studies confirm that intangibles have future economic benefits included in them. This study examined whether analysts consider intangibles to be similar in economic value, regardless of the accounting treatment assigned to them. It conducted four experiments by providing 26 analysts with future earnings potentials, and asking them to forecast stock prices for three companies over three firms’ continuous years. One firm had an internally produced brand, the second company had a bought brand, and the third firm had an internally produced brand and bought brands. These three firms were used in four forecasting environments designed for this study. Each forecasting environment constituted an experiment. Each forecasting environment differed, with capital market information specific to each firm. Provided with this information, the analysts forecast stock prices for the three firms in each of the four experiments. Comparing the forecast stock prices, the study found that the two brand classes had similar influence on analysts’ stock pricing forecasts, to infer them as equivalent in economic value, in each of the four forecasting environments.     

Do analysts follow emerging economy firms with higher intangible assets? Empirical evidence from Egypt

This paper tests whether analyst coverage and effort are related to the level of intangible assets reported by Egyptian listed firms. Intangible assets represent increasingly important investments for many firms, but most of these assets are not capitalized under prevailing accounting standards. Analysts reduce the information asymmetry by examining both financial reports and other information. Many Egyptian firms today seek access to foreign capital. I hypothesize that the larger the potential intangible assets of firms the more analysts will cover these firms and pursue private information about these firms. Sample consists of 435 firm-year observations over the period 1999–2007, and intangible assets are measured using eight different firm- and industry-level proxies. Consistent with prior research, results suggest that coverage is significantly associated with firm R&D, industry advertising expenses, firm size, and trading volume. Results also suggest that analyst effort is a function of firm and industry-level R&D expenses and firm size.     

A Comparison of Between‐Country Measures of Legal Setting and Enforcement of Accounting Standards

Academics and practitioners agree that the enforcement of accounting standards has an important role in promoting high quality financial reporting and favourable capital market outcomes. We test three new enforcement proxies from Brown, Preiato and Tarca (2014) that focus specifically on auditing and accounting enforcement. We examine firms’ information environments, represented by the error in analysts’ consensus forecasts and the extent of disagreement among analysts, as indicated by forecast dispersion. For financial years ending from 2003 to 2009, we construct a sample of 357,034 firm–month observations on the errors and dispersion of analysts’ earnings forecasts for 10,769 firms domiciled in those 39 countries. We find that higher scores for all three proxies are associated with lower error and less disagreement in forecasts. In addition, we find that the indices have significant explanatory power when previously used enforcement proxies (such as Kaufmann et al.'s 2010 rule of law measure) are included in the regression models, pointing to the importance of specific measures of accounting enforcement. We conclude that accounting enforcement may be more important in securing favourable economic outcomes than has been previously realised, because researchers commonly have used noisier, more general legal proxies for enforcement that understate its marginal effects.     

The reform of accounting standards and audit pricing

This paper focuses on the reform of accounting standards in China in 2007 and investigates its impact on equilibrium pricing in the audit market. We find that the concentration of the audit market and the probability of issuing modified audit opinions do not significantly change, but that audit fees increase significantly after the adoption of the new accounting standards in China. Deeper analysis suggests that (1) the implementation of the new IFRS-based Chinese Accounting Standards (CASs) has increased the market risk faced by listed firms and thus auditors’ expected audit risk, causing an increase in audit fees, and (2) the degree of the increase in audit fees is positively related to the adjusted difference between net income according to the old CAS before 2007 and the new CAS after 2007. We thus conclude that the reform has had a significant impact on audit pricing in China.     

Do disclosures of selective access improve market information acquisition fairness? Evidence from company visits in China

Following an exogenous regulation change in China, we examine the impact of company visit disclosures on the fairness of market information acquisition. Before July 2012, company visits to Chinese listed firms were vaguely disclosed in annual reports long after they were conducted. After that, they were disclosed in detail within two trading days of their completion. Market reactions around visits are much stronger and more predictive of firms' future earnings if visits occurred after July 2012 and, thus, were disclosed in a timelier and more detailed manner. The timely disclosure of visit details also improves the forecast accuracy of non-visiting analysts, reduces forecast dispersion among analysts, and weakens the relative information advantages of visiting analysts. Because of this, visits are more concentrated on firms with poorer information environments, larger sizes, and manufacturing firms after July 2012, i.e., firms offering visitors larger potential benefits. In summary, the timely disclosure of visit details improves the fairness of information acquisition and decreases information asymmetry while causing information chilling effects for firms that provide fewer potential benefits to visitors.