Analyst independence and earnings management

We examine whether analyst independence contributes to analysts’ monitoring role in deterring accruals earnings management. We first report a negative association between earnings management and the ratio of independent analysts to brokerage analysts covering a firm. Next, through the lens of the promotion of independent sell-side research institutions by the 2003 Global Research Analyst Settlement, we document a significant decrease in earnings management on firms affected by the Global Settlement's mandate for time-limited support to back independent research institutions. Additionally, we find that, as the aforementioned support ended, the extent of monitoring effectiveness reverted to a level indistinguishable from that before the Global Settlement. Finally, using closures and mergers of independent research institutions as a quasi-natural experiment, we provide corroborating evidence consistent with analyst independence leading to more effective monitoring.     

Causal effect of analyst following on corporate social responsibility

I examine the influence of sell-side financial analysts on corporate social responsibility (CSR) and find that firms with greater analyst coverage tend to be less socially responsible. To establish causality, I employ a difference-in-differences (DiD) technique, using brokerage closures and mergers as exogenous shocks to analyst coverage, as well as an instrumental variables approach. Both identification strategies suggest that analyst coverage has a negative causal effect on CSR. Analyst coverage seems to influence CSR activities via analysts' influence on the value of managerial ownership and discretionary spending. My findings are consistent with the view that spending on CSR is a manifestation of an agency problem and that financial analysts curb such discretionary spending by disciplining managers.     

Accruals quality and analyst coverage

We provide evidence that analyst coverage increases as accruals quality decreases. This finding is consistent with the services of financial analysts becoming more valuable and in greater demand as accruals provide weaker signals about future cash flows. Further, it is accruals quality associated with innate uncertainty in the firm’s operating environment that attracts analysts even after controlling for operating uncertainty associated with cash flow and stock return volatility. This suggests that low quality accruals provide an opportunity for analysts to benefit from generating private information. Consistent with analysts providing compensating information, we find that forecasts for firms with lower accruals quality contain more private information.     

Analysts’ accrual-related over-optimism: do analyst characteristics play a role?

Bradshaw et al. (J Acc Res 39:45–74, 2001) find that analyst forecast over-optimism is greater for firms with high accruals. This “accrual-related over-optimism” is generally interpreted as evidence that analyst forecasts do not fully incorporate predictable earnings reversals associated with high accruals. We investigate whether analyst experience, access to resources (brokerage size), and portfolio complexity moderate the relation between over-optimistic forecasts and high accruals. We demonstrate the robustness of accrual-related over-optimism to controls for cash flow and prior forecast errors. We find that accrual-related over-optimism is lower for analysts with greater general experience and for analysts following fewer firms but find only limited evidence of lower accrual-related over-optimism for analysts from larger brokerages and for analysts following fewer industries.     

Predictive versus opportunistic earnings management,executive compensation,and firm performance

We examine the association between earnings management and an important component of corporate governance, the incentives provided through compensation. We argue that firms with predictive (opportunistic) earnings management, in which discretionary accruals do (do not) relate to future cash flows, provide a more (less) ideal setting for the use of compensation as incentives. Our empirical tests show that CEO compensation levels (measured by salary, bonus, and other forms of compensation) are positively related to predictive earnings management and negatively related to opportunistic earnings management. We also find that predictive earnings management is positively associated with future returns, whereas opportunistic earnings management is negatively associated with future returns. Overall, our results suggest that firms provide more incentives if their earnings are also more informative because of discretionary accruals.     

Do investment banks listen to their own analysts?

To what extent conflicts of interest affect the investment value of sell-side analyst research is an ongoing debate. We approach this issue from a new direction by investigating how asset-management divisions of investment banks use stock recommendations issued by their own analysts. Based on holdings changes around initiations, upgrades, and downgrades from 1993 to 2003, we find that these bank-affiliated investors follow recommendations from sell-side analysts in general, increasing (decreasing) their relative holdings following positive (negative) recommendations. More importantly, these investors respond more strongly to recommendations issued by their own analysts than to those issued by analysts affiliated with other banks, especially for recommendations on small and low-analyst-coverage firms. Thus, we find that investment banks “eat their own cooking,” showing that these presumably sophisticated institutional investors view sell-side recommendations as having investment value, particularly when the recommendations come from their own analysts.     

Earnings management around employee stock option reissues

We investigate market behavior in a setting where managerial incentives to manipulate earnings and market price should be apparent ex ante to market participants. We find evidence of abnormally low discretionary accruals in the period following announcements of cancellations of executive stock options up to the time the options are reissued. Nevertheless, analysts and investors are not misled. Discretionary accruals have little power in explaining stock price performance during this period. Moreover, discretionary accruals do not explain subsequent analyst forecast errors. Thus, our findings suggest that, in this transparent setting, analysts and investors do not respond to earnings management.     

Do analyst recommendations reflect shareholder rights?

We examine whether sell-side analyst recommendations reflect shareholder rights. Our rationale is that analysts should be influenced by external governance only if market participants do not efficiently price its value. We find that stronger shareholder rights are associated with more favorable recommendations. Further analysis reveals that analysts favor firms with strong shareholder rights only when strong rights appear to be warranted, but do not penalize firms for having strong rights when not needed. These findings occupy middle ground in the debate on the pricing efficiency of shareholder rights. Moreover, we find that firm value is positively associated with the strength of shareholder rights regardless of the expected external governance structure. The latter result is consistent with a “one-size-fits-all” interpretation, and implies that firms across the board could increase share value by reducing their number of anti-takeover provisions.     

Earnings management and abnormal returns: Evidence from the 1970–1972 Price Control Regulations

We examine the association between abnormal returns and earnings management in the context of price control regulations to test the construct validity of the earnings management model. Abnormal returns are used as a market–based measure, and discretionary accruals are employed to measure earnings management. Our results support the hypotheses that (1) price control regulations affect firms' security prices negatively, (2) firms make income–decreasing discretionary accruals to increase the likelihood of price increase approval, and (3) firms that are affected most negatively by the regulations manage earnings more aggressively. We conclude that the earnings management model we use in this study is capable of predicting opportunistic discretionary accruals.     

Earnings management following chief executive officer changes: the effect of contemporaneous chairperson and chief financial officer appointments

Using a sample of listed Australian firms from 1999 to 2007, we examine the relationship between discretionary accruals and concurrent senior management appointments. Employing panel data regression models and focusing on a measure of discretionary accruals that excludes the effect of transparent write‐downs such as restructuring charges, we find that chief executive officer (CEO) appointments, as a general phenomenon, are not significantly associated with opaque earnings management in the year of appointment or the following year. However, we find that CEO changes accompanied by a concurrent change in board chairperson are associated with significant income‐decreasing earnings management in the year of appointment. We detect no significant relationship between contemporaneous CEO and chief financial officer changes and discretionary accruals. We find no evidence of earnings management in the first compete financial period following CEO appointment, regardless of whether or not concurrent Chair or chief financial officer appointments occurred.     

Conflicts of interest in sell-side research and the moderating role of institutional investors

Because sell-side analysts are dependent on institutional investors for performance ratings and trading commissions, we argue that analysts are less likely to succumb to investment banking or brokerage pressure in stocks highly visible to institutional investors. Examining a comprehensive sample of analyst recommendations over the 1994–2000 period, we find that analysts’ recommendations relative to consensus are positively associated with investment banking relationships and brokerage pressure but negatively associated with the presence of institutional investor owners. The presence of institutional investors is also associated with more accurate earnings forecasts and more timely re-ratings following severe share price falls.     

Analyst talent,information, and insider trading

We examine 1984–2018 data and show that the talent or ability of sell-side financial analysts affects a covered firm's information environment—more so than the simple number of analysts covering a firm. We find that while analysts in general produce market and industry-level information, high-ability analysts contribute more firm-specific information. Firms covered by high-ability analysts experience significantly less insider trading prior to positive earnings news. Results only reside in opportunistic (not routine) trades. When an analyst initiates (terminates) coverage we find decreased (increased) subsequent insider trading. Both changes are primarily driven by analyst talent. Analyst ability also negatively relates to insider trading profitability.     

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.     

Does the Stock Market See a Zero or Small Positive Earnings Surprise as a Red Flag?

This study shows that firms collectively incur a cost for managing earnings and analyst expectations to meet earnings forecasts. We compare the coefficient in the regression of abnormal stock returns on earnings surprise (the earnings response coefficient [ERC]) across ranges of earnings surprises. The ERC for earnings surprises in the range [0, 1¢] is significantly lower than ERCs for earnings surprises in adjacent ranges for firm-quarters in the early and mid 2000s, but not for those in the 1990s. The results are robust to controlling for the sign of estimated discretionary accruals and the trajectory of analyst earnings forecasts. We further find that investors are right to be skeptical about earnings surprises in the range [0, 1¢]. The relation of future earnings surprise with current earnings surprise is more negative for current earnings surprises in that range than for those in any other range. Evidence also suggests analysts react negatively to earnings surprises in that range.     

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 intellectual capital disclosure in analysts' reports vary by firm characteristics?

In this paper, we explore how Australian sell-side financial analysts contribute to the supply of intellectual capital (IC) information in the capital market. Toward this end, we examine how types and semantic properties of IC disclosures in analyst reports vary by a number of firm-specific characteristics likely to be associated with voluntary corporate disclosure. Consistent with our expectations, we find that the uncertainty associated with forecasting firm's earnings and the IC intensity of the industry in which the firm operates are associated positively with the extent as well as several semantic properties of IC disclosure in analyst reports. Highlighting that IC disclosure in analyst reports is not always a function of the extent of IC disclosed by firm, we find a statistically significant but negative association between firm profitability and the extent and certain semantic properties of IC disclosure in analyst reports. Firm size was significantly and positively associated with only the extent of forward-looking IC disclosure. Of the three categories of IC, only relation capital disclosure varied with any of the explanatory variables. Our findings highlight the importance of analyst reports as an IC communication media that could complement corporate communications of IC not only for firms disclosing less IC information voluntarily but also for those firms known to disclose more.     

Earnings Management and the Post‐earnings Announcement Drift

We posit that the post‐earnings announcement drift (PEAD) is related to earnings management. Accordingly, we find that firms with large negative (positive) changes in operating cash flows manage accruals upward (downward). Most importantly, we find that PEAD is concentrated largely among those firms that are most likely to have smoothed their reported earnings and is generally associated with discretionary accruals as opposed to nondiscretionary accruals. There is no evidence of a positive (negative) PEAD for those firms with large positive (negative) earnings changes that are least likely to have managed earnings downward (upward).     

Does an anti-corruption campaign increase analyst earnings forecast optimism?

We examine the impact of an anti-corruption campaign on analyst earnings forecast optimism. Using hand-collected site visits data by the Central Inspection Team (CIT) in China that began in 2013, we document higher analyst optimism during CIT visit periods than during non-CIT visit periods. The results are robust to matched samples, placebo tests, alternative fixed effect and clustering specifications, endogeneity of CIT site visits concern, and alternative samples. Additional analysis suggests that local government pressure and firm bad-news-hiding explain the findings but it is not consistent with the improved firm fundamentals interpretation. Moreover, we find that the effect of CIT visits on analyst optimism is more pronounced for star, non-affiliated, and experienced analysts, supporting the notion that, because of their greater influence, local governments focus on pressuring these analysts. More important, the impact of CIT visits on analyst optimism is more salient if a CIT leader had previous work experience or longer work experience in the inspected province. Interestingly, we document a reversion in analyst earnings forecast optimism 60 days after CIT site visits, especially among the non-state-owned firms, suggesting that, after the CIT investigation, analyst optimism is no longer needed.     

Asset write-offs discretion and accruals management in Taiwan: the role of corporate governance

Using a sample of Taiwan’s public firms, this paper examines whether managers use discretionary write-offs and abnormal accruals jointly to reach earnings targets and how corporate governance mechanisms react to such opportunistic behavior. We develop a set of simultaneous equations that capture executives’ incentives to manage earnings through write-offs and accrual management. These incentives include the existence and tightness of accounting-based covenants, “big bath,” income smoothing, and changes in senior management. The empirical results show that firms with larger discretionary write-offs also have lower discretionary accruals. In addition, we find that these earnings management tools are endogenous, suggesting that discretionary write-offs and discretionary accruals are partial complements for earnings manipulation and that their magnitudes are determined jointly. These findings contrast sharply with the tenor of discussion in the U.S. literature concerning the potential for using asset write-offs and discretionary accruals to manipulate earnings, which documents that managers use their discretion over accruals to signal economic realities rather than to obfuscate. Moreover, the results reveal that the empirical association between discretionary write-offs and abnormal accruals is more pronounced in weakly governed firms, suggesting that a strong governance setting is likely to constrain management’s discretionary behavior. The above implications are robust to a number of alternative specifications and variables definitions.     

The quality of street cash flow from operations

We provide empirical evidence on the quality of street cash flow from operations (CFO) as an alternative financial performance summary measure. We focus our investigation on the quality of the items analysts exclude in their determination of street CFO. Based on a sample of 8,518 firm-year observations over the 1993–2008 period, we find that the street CFO number is generally higher than the GAAP CFO number, indicating that analysts typically make CFO-increasing exclusions. Our inspection of hand-collected analyst reports reveals that, while some analysts make sophisticated exclusions of transitory cash items, many others ignore working capital and other accruals when adjusting forecasted earnings to arrive at their street CFO forecasts. We find that street CFO exclusions are negatively associated with future operating earnings, suggesting that these exclusions are not fully transitory or unimportant in forecasting future performance. Our results also indicate that street CFO exclusions are less transitory than the implicit accrual component of analysts’ street earnings exclusions. These results suggest that the average quality of analysts’ street CFO exclusions is quite low and that it is even lower than the quality of their implied accrual exclusions. Moreover, we find that investors perceive analysts’ CFO exclusions to be of such low quality to render street CFO measures less informative than GAAP CFO figures. Finally, we find that analyst conflicts of interest and (to some extent) the greater inherent volatility of firms’ CFO series contribute to the low-quality nature of analysts’ street CFO exclusions.