Analyst revenue forecast reporting and the quality of revenues and expenses

We decompose earnings quality into revenue and expense quality and examine their associations with analyst propensity to supplement their earnings forecasts with revenue forecasts. Analysts report more revenue forecasts to I/B/E/S when expense quality is low to compensate for the low accuracy of their earnings estimates, which has a positive association with expense quality. Expense quality is unassociated with revenue forecast accuracy, thus revenue forecasts become increasingly useful for valuing firms when expense quality is low. Analysts report fewer revenue forecasts when revenue quality is low because both earnings and revenue forecast accuracy decline as revenue quality deteriorates. To control for endogeneity, we use firm‐fixed effects to control for unobserved time‐invariant heterogeneity across firms, instrumental variables regressions and regression in changes.     

Determinants of analysts’ revenue forecast accuracy

This study investigates financial analysts’ revenue forecasts and identifies determinants of the forecasts’ accuracy. We find that revenue forecast accuracy is determined by forecast and analyst characteristics similar to those of earnings forecast accuracy—namely, forecast horizon, days elapsed since the last forecast, analysts’ forecasting experience, forecast frequency, forecast portfolio, reputation, earnings forecast issuance, forecast boldness, and analysts’ prior performance in forecasting revenues and earnings. We develop a model that predicts the usefulness of revenue forecasts. Thereby, our study helps to ex ante identify more accurate revenue forecasts. Furthermore, we find that analysts concern themselves with their revenue forecasting performance. Analysts with poor revenue forecasting performance are more likely to stop forecasting revenues than analysts with better performance. Their decision is reasonable because revenue forecast accuracy affects analysts’ career prospects in terms of being promoted or terminated. Our study helps investors and academic researchers to understand determinants of revenue forecasts. This understanding is also beneficial for evaluating earnings forecasts because revenue forecasts reveal whether changes in earnings forecasts are due to anticipated changes in revenues or expenses.     

Does revenue-expense matching play a differential role in analysts’ earnings and revenue forecasts?

This paper investigates whether matching has differential implications for the accuracy of analysts' earnings and revenue forecasts. We construct a novel measure of firm-level matching and document that matching improves analysts' earnings forecasts to a greater extent than their revenue forecasts. We also document matching's differential impact on analysts' earnings and sales forecasts by proposing a new count metric capturing a wedge in the accuracy of earnings and revenue forecasts. In additional tests, we report that the differential impact of matching is less (more) pronounced in a situation where the balance sheet (income statement) orientation likely dominates. We also report that matching's differential role is weaker (stronger) when firms have high intangible intensity (analysts have appropriate resources or expertise). In short window tests, matching's role in analysts' forecast revisions is more pronounced for earnings than sales forecasts. Overall, these results show how analysts benefit from better revenue-expense matching.     

Beating market expectations and the pricing of firms’ probability of default

This study explores the impact of beating analysts' forecasts on investors' perceptions about firms' default probability. The information contained in analysts’ forecasts, both earnings and revenues, provides additional information to investors in pricing CDSs. While previous research has focused on the impact of beating analysts’ earnings forecasts, this study shows that firms that beat analysts' revenue forecasts also experience, on average, a decrease in the CDS premium around the earnings announcement date. This study also documents that the effect is stronger when firms beat/miss both earnings and revenue forecasts. When firms beat (miss) earnings and miss (beat) revenues, the effect of earnings is the dominant signal. These effects are stronger for firms with high levels of default risk.     

Improving the Precision of Analysts' Earnings Forecasts by Adjusting for Predictable Bias

This research demonstrates that publicly-available information can be used to develop estimates of analysts' optimistic bias in earnings forecasts. These bias estimates can be used to produce more accurate forecasts, resulting in significant reductions of both cross-sectional mean forecast error and error variance. When bias estimates are based on past observations of forecast error alone, however, reductions in mean forecast error are smaller, and forecast precision is unimproved. Further tests provide evidence of a significant association between returns and the bias predictable from contemporaneously-available information, suggesting that predictable bias is only partially discounted by market participants. This study has significant implications for researchers and investors. The pricing of predictable bias in analysts' forecasts may add error toinferences which are based on the association between returns and analyst forecast errors, and knowledge of the market's partial discounting of predictable bias may help investors to make more efficient resource allocations.     

Business Cycle and Management Earnings Forecasts

This study examines the effects of the economic cycle on the properties of management earnings forecasts. Although a large volume of accounting literature examines the determinants of managerial earnings forecasts, the properties of such forecasts, and the response of market participants to earnings forecasts (Cameron 1986; King et al., 1990; Hirst et al., 2008), research on management earnings forecasting incentivized by macro‐economic factors has received scant empirical investigation. We use the National Bureau of Economic Research economic cycle definition to operationalize economic recession, and consider some commonly used management earnings forecast characteristics, including forecast likelihood, forecast frequency, forecast error, forecast pessimism, and forecast precision. We find that the likelihood of providing management earnings forecasts and frequency of forecasts increases during economic recession. We also find that economic recession is positively associated with forecast error, but negatively associated with forecast precision. Our findings suggest macro‐economic factors as an important determinant of management earnings forecasts properties.     

Market implied future earnings and analysts’ forecasts

This study provides evidence on market implied future earnings based on the residual income valuation (RIV) framework and compares these earnings with analyst earnings forecasts for accuracy (absolute forecast error) and bias (signed forecast error). Prior research shows that current stock price reflects future earnings and that analyst forecasts are biased. Thus, how price-based imputed forecasts compare with analyst forecasts is interesting. Using different cost of capital estimates, we use the price-earnings relation and impute firms’ future annual earnings from three residual income (RI) models for up to 5 years. Relative to I/B/E/S analyst forecasts, imputed forecasts from the RI models are less or no more biased when cost of capital is low (equal to a risk-free rate or slightly higher). Analysts slightly outperform these RI models in terms of accuracy for immediate future (1 or 2) years in the forecast horizon but the opposite is true for more distant future years when cost of capital is low. A regression analysis shows that, in explaining future earnings changes, analyst forecasts relative to imputed forecasts do not impound a significant amount of earnings information embedded in current price. In additional tests, we impute future long-term earnings growth rates and find that they are more accurate and less biased than I/B/E/S analyst long-term earnings growth forecasts. Together, the results suggest that the RIV framework can be used to impute a firm’s future earnings that are high in accuracy and low in bias, especially for distant future years.     

How do financial analysts interpret industrial firms' corporate refocusing announcements?

This study investigates how analysts perceive the effect of corporate refocusing announcements on UK industrial firms' future earnings by examining current-year and one-year-ahead earnings forecast revisions, current-year target price revisions and earnings forecast errors in the five years surrounding a refocusing announcement year. The results reveal that analysts adjust their earnings forecasts downward in a refocusing announcement year and the following two years, predicting that operating performance in the post-refocusing period is likely to decline relative to their former earnings forecasts. Secondly, there is no evidence that analysts issue biased earnings forecasts after refocusing announcements or that their forecasts appear less accurate. Thirdly, they adjust their earnings forecasts downward in a refocusing announcement year with downward market movement. However, they do not similarly adjust their earnings forecast upward with upward market movement. The magnitude of downward adjustments exceeds that of upward adjustments. They also adjust current-year target price forecasts downward with downward market movement in the year prior to a refocusing announcement.     

Earnings forecast disclosure regulation and earnings management: evidence from Taiwan IPO firms

This study examines whether the Taiwanese regulation requiring disclosure of earnings forecasts in the IPOs resulted in disclosure of more optimistic earnings forecasts and whether the forecast error was reduced more by manipulating the reported earnings rather than revising the earnings forecasts to meet the forecast error threshold. The study is based on 759 forecasts issued by the Taiwanese IPO firms from 1994 to 2001, i.e. 8-year period after the regulation was modified to increase the forecast error threshold to 20%. The findings show that the disclosure regulation resulted in more optimistic forecasts than conservative forecasts, especially for firms expecting better performance in the forecast year compared to the previous year. Firms disclosing optimistic earnings forecasts engaged more in manipulation of reported earnings than revision of forecasts to meet the forecast error threshold. These findings thus suggest that the disclosure regulation resulted in earnings manipulation, which reduced the quality of reported earnings. We received valuable comments at the 2003 American Accounting Association and 2004 Euorpean Accounting Association annual meetings. We also thank the participants at the research seminars at Rutgers University, City University of Hong Kong, and Pace University, for their insightful comments. Picheng Lee especially thanks Pace University for 2003 summer research grant.     

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.     

Determinants and consequences of information processing delay: Evidence from the Thomson Reuters Institutional Brokers’ Estimate System

We present new evidence that highlights the role of information intermediaries in the distribution and processing of earnings estimates in capital markets. We find that the time taken to activate an analyst's earnings forecast in the Thomson Reuters Institutional Brokers’ Estimate System is related to measures of investor demand for timely information processing, processing difficulty, and limited attention. Furthermore, we find that forecast announcement returns are muted and post-announcement drift is magnified for forecasts with longer unexpected activation delay and that market inefficiency is concentrated in neglected stocks and potentially exploitable. Finally, analyzing intraday returns, we find that activations facilitate price discovery.     

Alternative adjustments to analysts' earnings forecasts: relative and complementary performance

This study examines the relative and complementary performance of alternative earnings forecast adjustments using a common set of consensus analysts’ earnings forecasts. We document that a simple adjustment to analysts’ earnings forecasts, based solely on cross-sectional relationships between actual and forecasted earnings in the prior year, performs as well as more complicated adjustment methods, i.e., composite forecasts and persistence adjusted forecasts. A forecast adjustment that is based on prior year earnings and returns, however, provides significant incremental reductions in forecast error and dominates all of the other adjustment methods.     

How do auditors view managers’ voluntary disclosure strategy? The effect of earnings guidance on audit fees

The objective of this study is to examine the relation between attributes of earnings forecasts issued by managers and audit fees. Although there is an extensive literature on managers’ disclosure of earnings forecasts, there is a paucity of research on how auditors incorporate information from these voluntary disclosures. We find that the issuance of an annual or quarterly management earnings forecast in the prior period is positively associated with the current period audit fees. Our results indicate that on average, audit fees are higher by about 7% for firm-years associated with an annual forecast. Among the firms that issue earnings forecasts, we find no association between audit fees and likelihood of updating a previously issued earnings forecast, indicating that auditors do not view such behavior negatively. Further, we find audit fees to be positively associated with the error and the bias (or optimism) in the forecasts for annual forecasts but not for quarterly forecasts. Overall, these results suggest that management’s forecast behavior captures higher business risk for the auditor via greater risk of earnings management or litigation risk.     

Analysts’ earnings forecast errors and cost of equity capital estimates

This study investigates the relation between analysts’ forecast errors and cost of equity capital estimates implied from analysts’ earnings forecasts and price. My analysis predicts and removes forecast errors from analysts’ earnings forecasts on an out-of-sample basis and then uses these adjusted analysts’ forecasts to reverse-engineer cost of equity capital estimates. While the correction for predictable analysts’ forecast errors meaningfully lowers each of three firm-level implied COEC estimates employed in this study and commonly used in the literature, I do not find that this correction improves their association with realized returns.     

A new approach to predicting analyst forecast errors: Do investors overweight analyst forecasts?

I provide evidence that investors overweight analyst forecasts by demonstrating that prices do not fully reflect predictable components of analyst errors, which conflicts with conclusions in prior research. I highlight estimation bias in traditional approaches and develop a new approach that reduces this bias. I estimate characteristic forecasts that map current firm characteristics into forecasts of future earnings. Contrasting characteristic and analyst forecasts predicts analyst forecast errors and revisions. I find abnormal returns to strategies that sort firms by predicted forecast errors, consistent with investors overweighting analyst forecasts and predictable biases in analyst forecasts influencing the information content of prices.     

Mandatory CSR disclosure and analyst forecast properties: Evidence from a quasi-natural experiment in China

Based on a quasi-natural experiment that mandates a subset of listed firms to issue standalone corporate social responsibility (CSR) reports, we examine whether mandatory CSR disclosure improves analysts’ information environment. We focus on two properties of analysts’ earnings forecasts: forecast error and forecast dispersion. We find that the mandatory issuance of standalone CSR reports is related to less forecast error and less dispersed forecasts, and the effect varies with the firm-level information environment and province-level marketization. Additional tests show that the improvement in forecast properties is mainly driven by CSR reports that i) are of high quality and ii) contain more long-term-oriented information than other CSR reports. Our findings provide evidence that mandatory CSR disclosure plays an important informational role for financial analysts.     

Analyst characteristics, timing of forecast revisions, and analyst forecasting ability

We first examine whether analysts with certain characteristics that prior research has identified are related to superior forecasting ability systematically time their forecast revisions later in the fiscal quarter. We then examine whether this superior ability persists after controlling for the timing advantage by using relative forecast error, a measure that largely eliminates the timing advantage of recent forecasts. Using a sample of quarterly earnings forecast revisions over the 20-year period from 1990 to 2009, we find that analysts with more firm-specific and general experience and more accurate prior-period forecasts, analysts employed by larger brokerage firms, and analysts who follow fewer industries and companies tend to revise forecasts later in the quarter. We also find that analyst characteristics that are positively correlated with revision timing are negatively related to relative forecast errors. These results are consistent with analyst characteristics being useful proxies for analyst forecasting ability and analysts with greater ability revising forecasts later in the quarter.     

Do Analysts Disclose Cash Flow Forecasts with Earnings Estimates when Earnings Quality is Low?

Cash flows are incrementally useful to earnings in security valuation mainly when earnings quality is low. This suggests that when earnings quality decreases, analysts will be more likely to supplement their earnings forecasts with cash flow estimates. Contrary to this prediction, we find that analysts do not disclose cash flow forecasts when the quality of earnings is low. This is because cash flow forecast accuracy depends on the accuracy of the accrual estimates and the precision of accrual forecasts decreases for firms with low quality earnings. Consequently, as earnings quality decreases, cash flow forecasts become increasingly inaccurate compared to earnings estimates. Cash flow estimates that lack reliability are not useful to investors and, consequently, unlikely to be reported by analysts. This result provides an explanation for why analysts are less likely to report cash flow estimates when earnings quality is low.     

The Impact of Analysts' Forecast Errors and Forecast Revisions on Stock Prices

Abstract:  We present a comprehensive analysis of the association between stock returns, quarterly earnings forecast errors, and quarter-ahead and year-ahead earnings forecast revisions. We find that forecast errors and the two forecast revisions have significant effects on stock prices, indicating each conveys information content. Findings also show that the fourth quarter differs from other quarters—the relative importance of the forecast error (quarter-ahead forecast revision) is lower (higher). We also find a marked upward shift over time in the forecast error and forecast revision coefficients, consistent with the I/B/E/S database reflecting an improved quality of both earnings forecasts and actual earnings.     

Archival data of financial analysts' earnings forecasts in the euro zone: Problems with euro conversions

In multi-country studies, researchers frequently extract data in a single currency rather than in native currencies. This approach can be misleading for financial analysts’ forecasts in the euro zone when researchers are using the IBES database. We suspect that forecasts of earnings before the birth of the euro on January 1, 1999 are kept in national currencies, although they are supposed to be displayed in euros, which can severely distort results concerning earnings forecast accuracy. We propose a simple procedure for checking for the existence of this error, as well as a quick solution to overcome it.