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.     

Market uncertainty and the importance of media coverage at earnings announcements

We investigate whether increased investor demand for financial information arising from higher market uncertainty leads to greater media coverage of earnings announcements. We also investigate whether greater coverage during times of higher uncertainty further destabilizes financial markets because of greater attention-based trading or, alternatively, improves trading and pricing by lowering investor acquisition and interpretation costs. When uncertainty is higher, we find evidence of greater media coverage of earnings announcements and that the greater coverage leads to improvements in investor informedness, information asymmetry, and intraperiod price timeliness, and greater trade by both retail and institutional investors. In contrast to the media serving an expanded role in improving capital markets during more uncertain times, we fail to find that changes in firm-initiated disclosures lead to similar improvements and find that less frequent analyst forecast revisions exacerbate problems in capital markets during earnings announcements.     

Team earnings forecasting

While brokerage houses use both teams of sell-side analysts and individual analysts to conduct earnings research, there is no empirical research examining whether teams and individuals differ with regard to their forecasting performance or purpose. We first examine the most-often researched dimension of forecasting performance, earnings forecast accuracy, and show that teams are less accurate than individual analysts in general and their own individual team members in particular. We conjecture that teams focus their efforts on an alternative dimension of forecasting performance, timeliness, and show that team forecasts are timelier than those of individual analysts in general and their own individual team members in particular. Consistent with the notion that teams trade-off forecast accuracy for timeliness to comply with a market research demand, we show that team forecast revisions are associated with larger market responses than those of individuals. Finally, we illuminate the nature of team assignments by documenting that the firms that teams follow are in greater financial distress and larger in size.     

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.     

The sensitivity of the credit default swap market to financial analysts’ forecast revisions

We examine the impact of analysts’ earnings per share (EPS) and cash flow per share (CPS) forecast revisions on the market for credit default swaps. We find that while the issuance of both EPS and CPS forecast revisions are inversely associated with changes in credit default swap (CDS) spreads, cash flow forecast revisions have a larger effect. We demonstrate that the relationship between CPS forecast revisions and CDS spreads tends to be stronger in cases of financial distress. We provide evidence that cash flow forecasts dominate earnings forecasts in some situations and that participants in the CDS market discriminate between analysts' forecast revisions and recommendation changes.     

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.     

The role of analyst forecasts in the momentum effect

We evaluate the extent to which sell-side equity analysts can facilitate market efficiency when there is increasing uncertainty about a stock's future value. The prevalence of the 52-week-high momentum anomaly, that can be largely attributed to information uncertainty, provides a setting for examining the value and timing of analysts' earnings forecast revisions. Our study finds that analysts can provide value-relevant signals to investors by picking up indicators of momentum. The ability to identify under or over-valued stocks suggests that analysts are important information intermediaries in the price-continuation momentum effect. However, we also observe pervasive asymmetric reaction to good and bad news throughout our study that is consistent with incentive-driven reporting and optimistic biases. Nevertheless, analysts' forecast revisions are informative at different stages to re-establish stock prices back to their fundamental valuation.     

Slow price reactions to analysts’ recommendation revisions

This study explores the reasons for the slow price reactions to analysts’ recommendation revisions. We predict that analysts’ recommendation revisions contain earnings-related information that is not incorporated in analysts’ earnings forecasts and that the slow price reaction is attributable to a gradual incorporation of this earnings-related information into stock prices. We find that, consistent with our prediction, stocks with recommendation upgrades subsequently experience more upward earnings forecast revisions than stocks with recommendation downgrades, and that the differences in subsequent stock returns between upgraded and downgraded stocks is attributable to differences between subsequent earnings forecast (especially, FY2 earnings forecast) revisions.     

Analyst Firm Coverage and Forecast Accuracy: The Effect of Regulation Fair Disclosure

In this study, we revisit the relationship between analyst firm coverage and forecast accuracy. In contrast to the proposed negative association in Clement (1999) owing to the portfolio complexity effect, we hypothesize an ‘economy‐of‐scale effect’ that is likely to dominate when analysts rely mostly on public information. In support of the latter effect, we find a positive association between firm coverage and forecast accuracy after the enactment of Regulation Fair Disclosure (Reg FD), which substantially reduces the flow of material private information to analysts. Such a result survives a battery of robustness analyses. We further show that, in the post‐Reg FD period, covering more firms increases an analyst's probability of being selected as a star analyst in the subsequent year. Overall, our findings highlight the importance of the information environment in shaping the economic link between an analyst's firm coverage and forecast accuracy.     

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.     

Analyst reputation and management earnings forecasts

Prior studies show that analysts with high reputation are influential in the market. This paper examines whether managers consider analyst reputation in shaping their voluntary disclosure strategy. Using Institutional Investor magazine’s All-American (AA) rankings as a proxy for analyst reputation, we find that the coverage of AA analysts is positively associated with the likelihood of quarterly management earnings forecasts (MEFs). We also find that AA analysts’ forecast optimism is more positively associated with the likelihood of MEFs than non-AA analysts’ forecast optimism when the firm is covered by AA analysts. Analyses based on AA analyst coverage changes and AA status changes confirm the relation between analyst reputation and MEFs. We further find that analyst reputation influences other MEF properties, such as forecast news, bias, and revisions, and that our results are robust to alternative measures of analyst reputation. Further analyses show that market reactions at quarterly earnings announcements are more positive (negative) when firms meet/beat (miss) AA analysts’ forecasts than when firms meet/beat (miss) non-AA analysts’ forecasts. Collectively, our findings suggest that managers strategically provide voluntary forecasts by taking into account the reputation of individual analysts following their firms.     

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.     

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.     

Financial Analyst Characteristics and Herding Behavior in Forecasting

This study classifies analysts' earnings forecasts as herding or bold and finds that (1) boldness likelihood increases with the analyst's prior accuracy, brokerage size, and experience and declines with the number of industries the analyst follows, consistent with theory linking boldness with career concerns and ability; (2) bold forecasts are more accurate than herding forecasts; and (3) herding forecast revisions are more strongly associated with analysts' earnings forecast errors (actual earnings—forecast) than are bold forecast revisions. Thus, bold forecasts incorporate analysts' private information more completely and provide more relevant information to investors than herding forecasts.     

Causal language intensity in performance commentary and financial analyst behaviour

We use automated techniques to measure causal reasoning on earnings‐related financial outcomes of a large sample of MD&A sections of US firms and examine the intensity of causal language in that context against extent of analyst following and against properties of analysts’ earnings forecasts. We find a positive and significant association between a firm's causal reasoning intensity and analyst following and analyst earnings forecast accuracy respectively. Correspondingly, analysts’ earnings forecast dispersion is negatively and significantly associated with causal reasoning intensity. These results suggest that causal reasoning intensity provides incremental information about the relationship between financial performance outcomes and its causes, thereby reducing financial analysts’ information processing and interpreting costs and lowering overall analyst information uncertainty. Additionally, we find that decreases in analyst following are followed by more causal reasoning on performance disclosure. We also find that firms with a considerable increase of causal disclosure especially attract new analysts who already cover many firms. Overall, our evidence of the relationship between causal reasoning intensity and properties of analyst behaviour is consistent with the proposition that causal reasoning is a generic narrative disclosure quality characteristic, able to provide incremental information to analysts and guide analysts' behaviour.     

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.     

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.     

Private Placement of Common Equity and Earnings Expectations

We examine earnings forecast revisions by analysts subsequent to the announcement of private equity placements. Results show that analysts make significant upward revisions to their forecasts for current-year earnings. Furthermore, these forecast revisions are significantly related to announcement-period abnormal returns, but not to the risk changes accompanying the equity placement. These findings are consistent with the information hypothesis, which suggests that private equity placements convey favorable information about future earnings.     

Information content of equity analyst reports

We catalog the complete contents of Institutional Investor All-American analyst reports and examine the market reaction to their release. Including the justifications supporting an analyst's opinion reduces, and in some models eliminates, the significance of earnings forecasts and recommendation revisions. Analysts both provide new information and interpret previously released information. The information in a report is most important for downgrades; target prices and the analyst's justifications are the only significant elements for reiterations. No correlation exists between valuation methodology and either analyst accuracy or the market's reaction to a report. Our adjusted R²s are much larger than those of studies using only summary measures.