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.     

Analyst information production and the timing of annual earnings forecasts

We investigate whether the reputation-herding theory or the tradeoff theory explains variation in the timing of individual analysts’ forecasts. Using forecast accuracy improvements, forecast boldness, and the price impact of forecasts as measures of forecast quality, we find that in the information discovery phase that precedes an earnings announcement, earlier forecasts have higher quality than later forecasts. We also find a similar pattern in the information analysis phase that begins with the earnings announcement date. Our findings suggest that consistent with the herding theory, analysts who are more capable participate early in discovering and analyzing information, and therefore earlier forecasts in the information discovery and analysis phases are of higher quality than later forecasts in that phase.     

Performance of Malaysian IPOs: Underwriters reputation and management earnings forecasts

This paper examines the financial performance of Malaysian initial public offerings (IPOs) during the period 1980–1995. The major focus of the study is on the role of management earnings forecasts and underwriters in the valuation of IPOs. The results suggest extremely high and statistically significant initial premiums and positive and statistically significant long-term returns up to 3 years after listing. The findings for long-term returns contradict the consensus of the IPO literature that documents a significant negative long-term performance. Our results indicate a negative association of upward bias in management earnings forecasts with IPOs' performance during the first 12 months after the IPOs.     

Analyst versus model-based earnings forecasts: implied cost of capital applications

We find that a composite implied cost of capital (ICC) estimate – based on the earnings forecasts generated by cross-sectional models – is highly correlated with future realised returns in both portfolio- and regression-based tests. By contrast, we find very little evidence for an association with future realised returns for an ICC estimate based on analyst earnings forecasts. We also document the time-varying nature of expected returns and risk premia, and provide up-to-date estimates of an implied Australian market risk premium.     

Initiating coverage,broker reputation and management earnings forecasts in Australia

We examine more than 5000 recommendations made by Australian brokers in the period 1996–2001. We find evidence that initiating recommendations produce greater share price responses than continuing recommendations, particularly for hold, underperform and sell recommendations. We also find evidence that initiating recommendations made by higher‐reputation brokers and those made in the absence of a management earnings forecast attract different share price responses. Finally, we find that share price responses to initiating recommendations, conditional on the market consensus recommendation, are significantly different to continuing recommendations.     

Sources of earnings variability and their effect on earnings forecasts

Previous research shows that analysts’ forecasts of earnings do not fully incorporate information contained in reported earnings variability. This study investigates whether the inefficient forecast is because of a failure to incorporate observable information on two components of earnings variability: variability in operating performance and income smoothing. Our results show that analysts’ forecasts fully incorporate information contained in earnings variability for firms with high income smoothing and for firms with low operating variability. A smaller serial correlation of forecast errors is observed for firms with low operating variability, which suggests that analysts recognize the permanence in earnings for such firms.     

Analyst cash flow forecasts and pricing of accruals

This paper investigates how analyst cash flow forecasts affect investors' valuation of accounting accruals. We find that the strength of the accrual anomaly documented in Sloan (1996) is weaker for firms with analyst cash flow forecasts, after controlling for idiosyncratic risk, transaction costs and firm characteristics associated with the issuance of cash flow forecasts. We further show that this reduction in mispricing of accounting accruals is at least partially attributed to the improved ability of investors to price earnings manipulations imbedded in accruals. We investigate several non-mutually exclusive alternative explanations for this improvement in investors' ability and demonstrate that the increased investor attention and the improved accuracy of analyst earnings forecasts both contribute to the mitigation of the accrual anomaly.     

Analyst rounding of EPS forecasts and stock recommendations

We examine the association between analysts' stock recommendations and their tendency to round annual EPS forecasts to nickel intervals (i.e. placing a zero or five in the penny location of the forecast). We find that prior to Regulation Fair Disclosure (Reg FD), analysts were more likely to provide rounded EPS forecasts in association with unfavorable (underperform and sell) recommendations. However, after Reg FD, we find no significant association between rounded forecasts and unfavorable stock recommendations. Further, other regulations (NASD 2711, NYSE 472, and Global Research Analyst Settlement) have no impact on analyst rounding behavior. The findings in this study suggest that analyst rounding behavior is a particular form of forecasting optimism motivated, at least in part, by management relations incentives. Further, Reg FD appears partially successful at curbing the influence of management relations incentives on analysts' research.     

Reputation management and the disclosure of earnings forecasts

In this paper, managers differ from each other in terms of the probability that they are ??forthcoming?? (and disclose all the earnings forecasts they receive) or ??strategic?? (and disclose the earnings forecasts they receive only when it is in their self-interest to do so). Strategic managers choose whether to disclose their forecasts based on both the disclosure??s effects on their firms?? stock price and on their reputation among investors for being forthcoming. Our findings include: strategic managers can build a reputation for being forthcoming by disclosing unfavorable forecasts; managers?? incentive to build a reputation for being forthcoming may be so strong that they disclose even the most negative forecasts; as managers become more concerned about their reputation: (a) the current price of the firm in the event the manager makes no forecast increases; (b) managers who have a high probability of behaving strategically (as forthcoming) in the future issue forecasts more (less) often in the present.     

Evaluating the information content of earnings forecasts

This study develops a framework to compare the ability of alternative earnings forecast approaches to capture the market expectation of future earnings. Given prior evidence of analysts’ systematic optimistic bias, we decompose earnings surprises into analysts’ earnings surprises and adjustments based on alternative forecasting models. An equal market response to these two components indicates that the associated earnings forecast is a sufficient estimate of the market expectation of future earnings. To apply our framework, we examine four recent regression-based earnings forecasting models, alongside a simple earnings-based random walk model and analysts’ forecasts. Using the earnings forecasts of the model that satisfies our sufficiency condition, we identify a set of stocks for which the market is unduly pessimistic about future earnings. The investment strategy of buying and holding these stocks generates statistically signi?cant abnormal returns. We offer an explanation as to why this and similar strategies might be successful.     

The supply of analysts and earnings forecasts

Using a unique set of hand-collected data, this study examines whether a larger supply of prospective analysts leads to existing financial analysts' higher earnings forecast accuracy. We analyze the effect of the analyst supply proxied by the number of universities and the number of finance and economics universities located in the same city as the headquarters of brokerage firms. Our findings suggest that brokerage firms located closer to a larger supply of potential analyst candidates are associated with higher analyst forecast accuracy, as observed by a lower forecast error. We further find that the degree of employed analysts' effort acts as a mediator between the supply of prospective analysts and the accuracy of their earnings forecasts.     

Real earnings management and the properties of analysts' forecasts

Prior literature generally finds analysts are able to identify and process complex financial information. However, research suggests that in certain settings, analysts struggle to fully incorporate into their forecasts all available information. We examine analysts' forecast properties in the face of a specific type of complex financial information: real earnings management (REM). First, we investigate the relation between measures of REM and analysts' forecast properties. We find REM measures are associated with greater forecast error and dispersion in the following year. However, REM measures, by definition, capture abnormal operating results, and thus include both firms engaging in manipulative REM as well as firms experiencing firm-specific economic shocks. Thus, we conduct cross-sectional tests of analysts' forecasts for firms with and without incentives to manipulate earnings. We find that firms with low incentives to engage in earnings management (i.e., firms most likely experiencing firm-specific economic shocks) generate the strongest positive relation between REM measures and the following year's analysts' forecast properties, suggesting analysts more fully incorporate the earnings implications of firms with high incentives (i.e., firms most likely engaging in manipulative REM). Our results are consistent across numerous REM proxies and indicators of earnings management incentives.     

Investors’ reactions to retractions and corrections of management earnings forecasts

Timely voluntary disclosure of information by companies sometimes results in erroneous disclosure that must be later retracted (i.e., withdrawn) and/or corrected (i.e., replaced with a corrected disclosure). Although such retractions and corrections appear to be relatively easy and costless ways to fix the erroneous disclosure, our results generally show that both actions have unexpected effects on investor judgment. The results of four experiments, which are consistent with affect theory from psychology, indicate when a company provides a retraction of a previous erroneous voluntary disclosure, investors’ judgments continue to reflect the implications of the initial erroneous information. That is, investors under-adjust. In contrast, when a company provides a correction (alone or with a prior retraction) with an opposite earnings implication, investors tend to over-adjust. Our results also show that if investors do not form a strong initial affective reaction to the initial erroneous forecast, they are less prone to over-adjustment when the correction is later received. Implications for regulators and standard setters are provided.     

The Extreme Future Stock Returns Following I/B/E/S Earnings Surprises

We investigate the stock returns subsequent to quarterly earnings surprises, where the benchmark for an earnings surprise is the consensus analyst forecast. By defining the surprise relative to an analyst forecast rather than a time‐series model of expected earnings, we document returns subsequent to earnings announcements that are much larger, persist for much longer, and are more heavily concentrated in the long portion of the hedge portfolio than shown in previous studies. We show that our results hold after controlling for risk and previously documented anomalies, and are positive for every quarter between 1988 and 2000. Finally, we explore the financial results and information environment of firms with extreme earnings surprises and find that they tend to be “neglected” stocks with relatively high book‐to‐market ratios, low analyst coverage, and high analyst forecast dispersion. In the three subsequent years, firms with extreme positive earnings surprises tend to have persistent earnings surprises in the same direction, strong growth in cash flows and earnings, and large increases in analyst coverage, relative to firms with extreme negative earnings surprises. We also show that the returns to the earnings surprise strategy are highest in the quartile of firms where transaction costs are highest and institutional investor interest is lowest, consistent with the idea that market inefficiencies are more prevalent when frictions make it difficult for large, sophisticated investors to exploit the inefficiencies.     

The association of aggregate and disaggregated earnings with annual stock returns

This study compares aggregate earnings and disaggregated earnings (cash from operations, current accruals and non-current accruals) in terms of their associations with stock returns. A cross-sectional approach is adopted using Australian data over a six-year period. This analysis is undertaken for two different models of the relation between earnings and returns: one model relating returns to the magnitude of earnings, and the other relating returns to the combination of levels of, and changes in, earnings. In each model, the disaggregated regression is generally a superior explanator of stock returns, implying that disaggregated earnings provides richer information about firm performance, in a purely statistical sense, than aggregate earnings. Thus, disaggregated earnings are more informative, even in the most simple of comparison modes, linear regression.     

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.     

CEO career concerns and the precision of management earnings forecasts

Review of Quantitative Finance and Accounting - We extend the research on how CEOs address career concerns during their early tenure in firms and we argue that CEOs use a forecast precision...     

Macro information environment change and the quality of management earnings forecasts

The 1990s were characterized by substantial increases in the performance of and investor reliance on financial analysts. Because managers possess superior private information and issue forecasts to align investors’ expectations with their own, we predict that managers increased the quality of their earnings forecasts during the 1990s in order to keep pace with the improved forward-looking information provided by financial analysts, upon which investors increasingly relied. Using a sample of 2,437 management earnings forecasts, we document an increase in management earnings forecast precision, management earnings forecast accuracy, and managers’ tendency to explain earnings forecasts in 1993–1996 relative to 1983–1986. Given that these forecast characteristics are linked to greater informativeness and credibility, we also document that the information content of management earnings forecasts, as measured by the strength of share price responses to forecast news, increased in 1993–1996 relative to 1983–1986. As expected, the increased information content of management forecasts primarily occurred for firms covered by financial analysts.

Using earnings forecasts to simultaneously estimate firm-specific cost of equity and long-term growth

A growing body of literature in accounting and finance relies on implied cost of equity (COE) measures. Such measures are sensitive to assumptions about terminal earnings growth rates. In this paper we develop a new COE measure that is more accurate than existing measures because it incorporates endogenously estimated long-term growth in earnings. Our method extends Easton et al. (J Account Res, 40, 657–676, 2002) method of simultaneously estimating sample average COE and growth. Our method delivers COE (growth) estimates that are significantly positively associated with future realized stock returns (future realized earnings growth). Moreover, the predictive ability of our COE measure subsumes that of other commonly used COE measures and is incremental to commonly used risk characteristics. Our implied growth measure fills the void in the earnings forecasting literature by robustly predicting earnings growth beyond the five-year horizon.     

Audit committee financial expertise and properties of analyst earnings forecasts

An important role of financial accounting information is to aid financial statement users in forming expectations about the firm's future earnings. Prior research finds that accounting financial expertise of the audit committee is associated with higher financial reporting quality. We extend this literature by examining the association between audit committee financial expertise and analysts' ability to anticipate future earnings. We find a significant association between accounting financial expertise on the audit committee and analyst earnings forecasts that are more accurate and less dispersed. In contrast, we do not find a significant association between non-accounting financial expertise (i.e., supervisory expertise) and forecast accuracy or forecast dispersion. These findings contribute to our understanding of the benefits of accounting expertise in audit committees by demonstrating an association between accounting financial expertise and improvements in analyst earnings forecasts.