Do analysts mislead investors? A comparison of analysts' and investors' weightings of cash components in forecasting annual earnings

Abstract

Purpose

The purpose of this study is to examine whether financial analysts mislead investors in recognizing the differential persistence of the three cash flow components of earnings, defined by Dechow et al., in forecasting annual earnings.

Design/methodology/approach

The paper uses Mishkin's econometric approach to compare the persistence of the cash flow components within and across the historical, analysts' and investors' weightings.

Findings

It is found that financial analysts' weightings of the cash flow components are more closely aligned with the historical relations than are investors' weightings, both in direction and in magnitude. The degree of analysts' mis‐weighting is economically small and much lower than the degree of investors' mis‐weighting. Moreover, the extent of both investors' and analysts' mis‐weightings of the cash components is generally smaller for firms with greater levels of analyst following, a proxy for the quality of the information environment.

Research limitations/implications

The findings suggest that financial analysts' bias in weighting the cash components of earnings is at best a partial explanation for investors' bias.

Practical implications

This study is important to academics and the investment community that relies upon financial analysts as information intermediaries, because the ability of analysts to incorporate value‐relevant information in their published expectations may impact securities prices.

Originality/value

The study is the first to document the weightings of the cash components of earnings by financial analysts. In addition, this paper provides evidence that financial analysts, as information intermediaries, are less biased than investors in processing not only the accrual but also the cash components of earnings.

Citation

Lo, M.H. and Xu, L.(E). (2008), "Do analysts mislead investors? A comparison of analysts' and investors' weightings of cash components in forecasting annual earnings", Accounting Research Journal, Vol. 21 No. 1, pp. 33-54. https://doi.org/10.1108/10309610810891337