Who was informative? Performance of foreign and local analysts’ stock recommendations during the Asian financial crisis

This paper examines the performance of foreign and local analysts’ stock recommendations in Indonesia, Malaysia, Thailand, and South Korea during the financial crisis of 1997–1998. Unlike most of the prior studies, our results provide strong evidence that neither of the two groups held a complete information advantage over the other during the period of crisis. Using a large dataset of analysts’ recommendations, we show that foreign analysts’ buy recommendations were more informative than local analysts’ buy recommendations, while the opposite held for sell recommendations, i.e. local analysts’ sell recommendations were more informative than foreign analysts’ sell recommendations. Our results provide evidence that neither of the frequently advanced explanations regarding relative performance of foreign and local analysts hold during the period of extreme uncertainty.     

Can financial statement analysis beat consensus analysts’ recommendations?

We examine whether investors can exploit financial statement information to identify companies with a greater likelihood of future earnings increases and whether stocks of those companies generate 1-year abnormal returns that exceed the abnormal returns from following analysts’ consensus recommendations. Our approach summarizes financial statement information into a “predicted earnings increase score,” which captures the likelihood of 1-year-ahead earnings increases. We find that, within our sample of consensus recommendations, stocks with high scores are much more likely to experience future earnings increases than stocks with low scores. A hedge portfolio strategy that utilizes our approach within each consensus recommendation level generates average annual abnormal returns of 10.9 percent over our 12-year sample period, after controlling for previously identified risk factors. These abnormal returns exceed those available from following analysts’ consensus recommendations. Our results show that share prices and consensus recommendations fail to impound financial statement information that helps predict future earnings changes.     

CEO stock options and analysts’ forecast accuracy and bias

This paper investigates the relationship between CEO stock options and analysts’ earnings forecast accuracy and bias. A higher level of stock options may induce managers to undertake riskier projects, to change and/or reallocate their effort, and to possibly engage in gaming (such as opportunistic earnings and disclosure management). These managerial behaviors result in an increase in the complexity of forecasting and hence, less accurate analysts’ forecasts. Analysts’ optimistic forecast bias may also increase as the level of stock options pay increases. Because forecast complexity increases with stock options pay, analysts, needing greater access to management’s information to produce accurate forecasts, have incentives to increase the optimistic bias in their forecasts. Alternatively, a higher level of stock options pay may lead to improved disclosure because it better aligns managers’ and shareholders’ interests. The improved disclosure, in turn, may result in more accurate and less biased analysts’ forecasts. Our empirical evidence indicates that analysts’ earnings forecast accuracy decreases and forecast optimism increases as the level of CEO stock options increases. This evidence suggests that the incentive alignment effects of stock options are more than offset by the investment, effort allocation and gaming incentives induced by stock options grants to CEOs.     

Internal control material weakness, analysts’ accuracy and bias, and brokerage reputation

The main purpose of this paper is to examine the impact of internal control material weaknesses (ICMW hereafter) on sell side analysts. We find that ICMW reporting firms have less accurate analyst forecasts relative to non-reporting firms when the reported ICMWs belong to the Pervasive type. ICMW reporting firms have more optimistically biased analyst forecasts compared than non-reporting firms. The optimistic bias exists only in the forecasts issued by the analysts affiliated with less-highly-reputable brokerage houses. The differences in accuracy and bias between ICMW and non-ICMW firms disappear when ICMW disclosing firms stop disclosing ICMWs. Collectively, our results suggest that the weaknesses in internal control increases forecasting errors and upward bias for financial analysts. However, a good brokerage reputation can curb the optimistic bias.     

Do individual investors’ stock recommendations in online communities contain investment value?

This paper investigates the investment value of individual investors’ stock recommendations within online communities. We find that aggregated recommendations contain no explicit investment value and that following these recommendations may have a negative impact on investment performance. Our results suggest that recommendations are mostly based on simple heuristics and concentrate on a small number of stocks. When restricting the set of recommendations to those made by the most experienced or successful recommenders, results marginally improve but still preclude profitable investment strategies. Experienced and successful recommenders seem more likely to avoid the most expensive pitfalls rather than actually exhibit superior investment performance.     

Why are recommendations optimistic? Evidence from analysts’ coverage initiations

We examine the long-term stock performance of analyst recommendations and the properties of accompanied earnings forecasts for initiations and non-initiations to evaluate the reporting, selection, and processing explanations for analyst optimism. We find that Strong Buy and, to a lesser degree, Buy initiation recommendations underperform their non-initiation counterparts after controlling for analyst, brokerage, and firm characteristics associated with the initiation decision and expected long-term stock returns. Yet, earnings forecasts accompanying Strong Buy and Buy initiation recommendations are less optimistic and more accurate than those accompanying non-initiation recommendations. Our findings suggest that conflicts of interest (that is, the reporting explanation) are the dominant source for favorable recommendations.     

The role of “other information” in analysts’ forecasts in understanding stock return volatility

This study identifies “other information” in analysts’ forecasts as a legitimate proxy for future cash flows and examines its incremental role in explaining stock return volatility. We suggest that “other information” contains information about fundamentals beyond that reflected in current financial statements and reflects firms’ fundamentals on a more timely basis than dividends or earnings. Using standardized regressions, we find volatility increases when current “other information” is more uncertain and increases more in response to unfavorable news compared to favorable news. Variance decomposition analysis shows that the variance contribution of “other information” dominates that of expected-return news. The incremental role of “other information” is at least half of the effect of earnings in explaining future volatility. The results are more pronounced for firms with poor information environments. Overall, our results highlight the importance of including “other information” as an additional cash-flow proxy in future studies of stock prices and volatility.     

The characteristics of individual analysts’ forecasts in Europe

This study investigates the determinants of financial analysts’ forecasts differential accuracy in 14 different European stock markets. Using the I/B/E/S Detail History Database, I find that European financial analysts forecast accuracy is positively associated with analyst firm specific experience. Forecast accuracy is negatively associated with the number of countries followed by analysts and the age of the forecast. Surprisingly, I find no relationship between forecast accuracy and analysts’ job experience and the size of the bank employing the analyst.     

Errors and questionable judgments in analysts’ DCF models

We investigate the number of and reasons for errors and questionable judgments that sell-side equity analysts make in constructing and executing discounted cash flow (DCF) equity valuation models. For a sample of 120 DCF models detailed in reports issued by U.S. brokers in 2012 and 2013, we estimate that analysts make a median of three theory-related and/or execution errors and four questionable economic judgments per DCF. Recalculating analysts’ DCFs after correcting for major errors changes analysts’ mean valuations and target prices by between ?2 and 14 % per error. Based on face-to-face interviews with analysts and those who oversee them, we conclude that analysts’ DCF modeling behavior is semi-sophisticated in the sense that analysts genuinely make mistakes regarding certain aspects of correctly valuing equity but also respond rationally to the incentives they face, particularly the reality that they are not directly compensated for being textbook DCF correct.     

Anatomy of a regulatory race to the top: Changes in delisting rules at Korea's two stock exchanges, 1999–2002

One dimension of competition among stock exchanges is the quality of products they have to offer. In order to attract listings and trading volume, exchanges can affect the quality of their listed firms by altering their standards for firm disclosure and governance. We identify a competition with respect to delisting standards between Korea's two stock exchanges and show that it complies with the three components of a regulatory race to the top: external trigger, mobility among diverse regimes and meaningful changes that converge to similar rules. The race between the two Korean exchanges ended with stricter rules and better protected minority shareholders. The race also ended, however, with neither exchange gaining market share with respect to trading volume or new listings. Korea's experience, therefore, suggests a reason why these races are rare. In the absence of an external trigger, exchanges will be reluctant to enter a race if they think it will result in rule convergence and no winner.     

Does short selling reduce analysts’ optimism bias in earnings forecasts?

We examine the relationship between short selling and analyst optimism bias of earnings forecasts of stocks in China. We propose two possible hypotheses: short selling enhances analysts’ information set to lower optimism bias and analysts drum up optimistic earnings forecasts to counter short selling. Our results suggest that short selling and earnings optimism bias are negatively correlated. The findings are robust to a two-stage least square method, a difference in-differences fixed effect model, an alternative measure of optimism bias, incorporated different time windows to calculate short selling, considered bull and bear market conditions, accounting for media coverage, and using abnormal short selling. By leveraging rich data, we conduct additional analyses using stocks with different forecasting horizons and earnings forecasts that were made after the accounting year but prior to the earnings announcement to further support expanding the information set argument. Lastly, we document that short selling information improves the accuracy of earnings forecasts.     

Shifting corporate culture: executive stock ownership plan adoptions and incentives to meet or just beat analysts’ expectations

This paper investigates whether adoptions of executive stock ownership plans coincide with decreased incentives to meet or just beat analysts’ near-term EPS forecasts. Firms often assert that ownership plans focus executives on long-term performance. I find that the impact of these adoptions on meeting or just beating analysts’ EPS forecasts differs depending on whether the plan binds the CEO to reach ownership targets by a specified date. In particular, I find that firms that adopt plans requiring an increase in CEO ownership exhibit a lower propensity to meet or just beat earnings forecasts following plan adoptions. In contrast, firms that adopt plans that require no increase exhibit no change in the propensity to meet or just beat. The results suggest that firms use binding ownership plans to shift executives’ focus from near-term earnings benchmarks to long-term value creation.     

Skin in the game: personal stock holdings and investors’ response to stock analysis on social media

Review of Accounting Studies - Motivated by concerns that financial positions impair analyst objectivity, we examine investor perceptions of the financial positions of nonprofessional analysts...     

Investors’ risk perceptions in the US and global stock market integration

Investors’ risk perceptions have significant implications for international stock markets. This paper estimates the time-varying impact of the VIX index – a widely used measure of investors risk perceptions – on the dynamic correlation across international stock markets. Results show that risk perceptions significantly impact the dynamic correlation between the U.S. market and the leading stock markets of the world. Further, in 17 out of 20 international stock markets, risk perceptions Granger cause dynamic correlations. The impact of VIX is positive on the correlation of the U.S. market with European and Latin American markets. In contrast, the relationship of the U.S. market with all the Asian markets weakens (strengthens) as the VIX index rises (falls). In all cases, the time-varying parameter model shows that the impact of VIX on these correlations varies significantly across time.     

Motivations behind users’ participation in the standard-setting process: Focus on financial analysts

The aim of this study is to investigate what motivates financial analysts to participate in the accounting standard-setting process. We focus on financial analysts because they are an important group of the financial statements users. The paper employs the meso-level approach used by Durocher et al. (2007) that integrates the macro domain’s focus on the standard setters with the micro domain’s focus on individuals and thus it links the characteristics of due process for standard setting with users’ attitudes. We develop a survey for the Chartered Financial Analysts Institute (CFA), which is one of the largest associations of investment professionals in the world, and collected data through computer-assisted Web interviews. We use a structural equation model with PLS to test our hypotheses. Our main findings confirm that a combination of micro and macro domains explains the frequency of financial analysts’ participation in the standard setting process. This investigation, thus, deepens our understanding of motivations behind analysts’ involvement in the accounting standard-setting process and delivers both theoretical contributions and practical insights.     

The role of the business press in the pricing of analysts’ recommendation revisions

We investigate the information-dissemination role of the business press by examining the coverage of analyst recommendation revisions. Consistent with the press providing wider dissemination of analyst reports, we find evidence that coverage of analyst recommendation revisions significantly increases the initial market reaction to these revisions and decreases the subsequent price drift. Furthermore, we find that news flash coverage, rather than in-depth coverage, of a recommendation revision drives both the initial market reaction results and drift results. Finally, we show that broader press coverage influences the activities of large-trade institutional investors but not high-frequency traders. Overall, our findings suggest a complementary role between analysts and the business press: increased dissemination of recommendation revisions, rather than information creation on the part of the business press, serves to better inform the market about analyst recommendation revision decisions.

     

Do local analysts have an informational advantage in forecasting stock returns? Evidence from the German DAX30

Utilizing data from the German DAX30 stock index, we investigate whether local analysts have an informational advantage in forecasting stock returns. We analyze whether banks’ buy and sell recommendations improve on the out-of-sample predictability of daily stock returns and the market-timing ability of investors who base their decisions on such recommendations. We find that, indeed, in a few cases German banks do have better stock-forecasting ability for daily stock returns than do foreign banks. However, the value added of bank recommendations is generally small and sensitive to the model-selection criterion used by an investor in setting up a forecasting model for stock returns.     

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.     

Changes in audit effort and changes in auditors’ disclosures of risks of material misstatement

This paper investigates whether auditors' year-to-year modification to risks of material misstatements (RMMs) in extended auditors' reports (EARs) are associated with changes in underlying audit effort, as proxied by changes in audit fees. We examine the dynamics of RMMs over time in terms of adding or dropping specific RMMs. Our main results show that, on average, audit fees increase more from the previous year's fees when more RMMs are added to the current year's EAR. This increase is partially offset by dropping RMMs that were disclosed in the previous year, but changes in audit fees are not significantly affected by dropping RMMs without adding new RMMs. Further analysis suggests the effect of added RMMs is attributable to “new” RMMs originating with the auditor and that added RMMs that were previously known, based on related disclosures in the prior year's audit committee report, do not significantly impact on changes in audit fees. Overall, our results suggest that changes in the choice of RMMs included in EARs reflect changes in underlying audit effort.     

Improvement in clinical trial disclosures and analysts’ forecast accuracy: evidence from the pharmaceutical industry

This paper examines whether financial analysts use the information contained in clinical trial disclosures to improve their forecast accuracy for pharmaceutical companies. Findings indicate that the improved clinical trial disclosures due to a quasi-regulation issued by the International Committee of Medical Journal Editors (ICMJE) significantly reduce analysts’ long-term forecast error. In addition, a propensity-score matching analysis provides additional strong evidence that issuance of the 2005 ICMJE’s regulation is accompanied by an average 45 % decrease in long-term forecast error, and a more than 50 % decrease in long-term forecast dispersion. This study contributes to the accounting literature regarding nonfinancial disclosures by providing the first insights into financial analysts’ use of clinical trial disclosures in their forecasts of future earnings. In addition, because the major event examined in this study is a quasi-regulation issued by the ICMJE, we provide additional insights on the effectiveness of industry-initiated regulations (or quasi-regulations) on nonfinancial disclosure practice.