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Book part
Publication date: 14 November 2011

An Evaluation of Financial Analysts and Naïve Methods in Forecasting Long-Term Earnings

Michael Lacina, B. Brian Lee and Randall Zhaohui Xu

We evaluate the performance of financial analysts versus naïve models in making long-term earnings forecasts. Long-term earnings forecasts are generally defined as third-…

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Abstract

We evaluate the performance of financial analysts versus naïve models in making long-term earnings forecasts. Long-term earnings forecasts are generally defined as third-, fourth-, and fifth-year earnings forecasts. We find that for the fourth and fifth years, analysts' forecasts are no more accurate than naïve random walk (RW) forecasts or naïve RW with economic growth forecasts. Furthermore, naïve model forecasts contain a large amount of incremental information over analysts' long-term forecasts in explaining future actual earnings. Tests based on subsamples show that the performance of analysts' long-term forecasts declines relative to naïve model forecasts for firms with high past earnings growth and low analyst coverage. Furthermore, a model that combines a naïve benchmark (last year's earnings) with the analyst long-term earnings growth forecast does not perform better than analysts' forecasts or naïve model forecasts. Our findings suggest that analysts' long-term earnings forecasts should be used with caution by researchers and practitioners. Also, when analysts' earnings forecasts are unavailable, naïve model earnings forecasts may be sufficient for measuring long-term earnings expectations.

Details

Advances in Business and Management Forecasting
Type: Book
DOI: https://doi.org/10.1108/S1477-4070(2011)0000008009
ISBN: 978-0-85724-959-3

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Book part
Publication date: 19 September 2014

Can you Believe it? Managerial Discretion and Financial Analysts’ Responses to Management Earnings Forecasts

Guoli Chen and Craig Crossland

Financial analysts act as crucial conduits of information between firms and stakeholders. However, comparatively little is known about how these information intermediaries…

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Abstract

Financial analysts act as crucial conduits of information between firms and stakeholders. However, comparatively little is known about how these information intermediaries evaluate the believability and importance of corporate disclosures. We argue that a firm’s level of managerial discretion, or latitude of executive action, acts as a cue for financial analysts, which helps them interpret and respond to voluntary management earnings forecasts. Our study provides strong, robust evidence that financial analysts find management forecasts significantly less believable in low-discretion than in high-discretion environments, and therefore tend to be much less responsive to these forecasts. We also show that managerial discretion is especially impactful on analysts’ responses in those circumstances where analysts are typically most uncertain about how to interpret management forecasts.

Details

Finance and Strategy
Type: Book
DOI: https://doi.org/10.1108/S0742-332220140000031003
ISBN: 978-1-78350-493-0

Keywords

  • Managerial discretion
  • earnings forecasts
  • management guidance
  • strategic leadership
  • information intermediaries
  • analyst forecast revision

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Book part
Publication date: 30 September 2019

Investor Uncertainty Judgments and Perceptions of Analyst Herding: The Role of Motivated Reasoning

Walied Keshk

Although prior research documents that analysts sometimes herd their forecasts, very few studies investigate how investors’ judgments are influenced by their perceptions…

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Abstract

Although prior research documents that analysts sometimes herd their forecasts, very few studies investigate how investors’ judgments are influenced by their perceptions of the likelihood of analyst herding. I conduct an experimental study to investigate the conditions under which investors’ assessments of uncertainty about future earnings are influenced by their perceptions of the likelihood of analyst herding. As expected, and consistent with motivated reasoning, the results show that the temporal order of analyst forecasts influences investors’ estimates of the likelihood of analyst herding and investors’ uncertainty judgments when analyst forecasts are preference-inconsistent but not when analyst forecasts are preference-consistent. This study provides a potential explanation for the mixed findings of prior research in regard to investors’ reactions to the likelihood of analyst herding. In addition, this study extends research on investors’ credulity by providing evidence that motivated reasoning and skepticism may serve as a mechanism that contributes to that credulity.

Details

Advances in Accounting Behavioral Research
Type: Book
DOI: https://doi.org/10.1108/S1475-148820190000022005
ISBN: 978-1-83867-346-8

Keywords

  • Reactions to analyst herding
  • motivated reasoning
  • skepticism
  • temporal order of analyst forecasts
  • uncertainty about future earnings
  • investor credulity

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Book part
Publication date: 1 November 2018

The Influence of Corporate Governance Mechanisms on the Behavior of Financial Analysts of US Firms: An Empirical Analysis

Ahmed Bouteska

The aim of this paper is to analyze the impact of corporate governance (focused on some key mechanisms as board size, board independence, managerial ownership…

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Abstract

The aim of this paper is to analyze the impact of corporate governance (focused on some key mechanisms as board size, board independence, managerial ownership, institutional ownership, and chief executive officer duality) on financial analysts’ behavior in US. Results from panel data analysis for 294 US listed firms observed from 2007 to 2014 show that several attributes of the board of directors and audit committee have no effects on the number of analysts who are following the firm and the properties of analysts’ earnings forecasts. Findings also suggest that firms with independent and large boards and blockholders ownership benefit of more analyst following. In addition, it is proven that analysts’ earnings forecasts are optimistic and more accurate for companies where blockholder ownership, either by managers or external entities have larger quoted spreads but of lower quality for the ones which have greater independent board members and institutional investor’s holding.

Details

International Corporate Governance and Regulation
Type: Book
DOI: https://doi.org/10.1108/S1569-373220180000020006
ISBN: 978-1-78756-536-4

Keywords

  • Corporate governance
  • financial analysts
  • analyst following
  • analyst optimism
  • forecast accuracy
  • United States
  • G14
  • G24
  • G32
  • G38
  • M41

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Article
Publication date: 28 May 2020

The impact of insider trading on analyst coverage and forecasts

Guanming He and David Marginson

The purpose of this study is to examine the effect of insider trading on analyst coverage and the properties of analyst earnings forecasts. Given the central role of…

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Abstract

Purpose

The purpose of this study is to examine the effect of insider trading on analyst coverage and the properties of analyst earnings forecasts. Given the central role of analysts for information diffusion in stock markets, advancing understanding of the role insider trades may play in analyst coverage and forecasts, especially in the context of a changing legal environment (e.g. the implementation of Regulation Fair Disclosure [Reg FD]), should be a worthy goal.

Design/methodology/approach

To address the research questions, the authors run regressions in which the authors identify and control for as many possible determinants of analyst coverage and forecasts (e.g. firm size, information asymmetry and earnings performance) that are correlated with insider trades. To alleviate endogeneity concerns, the authors use three approaches. First, the authors extend the sample period to the post-Reg-FD period in which managers are not allowed to provide private information to financial analysts. Second, the authors measure analyst coverage in a window that is lagged by insider trades. Third, the authors employ firm-fixed-effects regressions in all the multivariate tests. Finally, following Larcker and Rusticus (2010), the authors conduct the impact threshold for a confounding variable test to assure that all regression analyses are indeed immune to the potential correlated-omitted-variable bias.

Findings

The authors find that the level of analyst coverage is positively related to the intensity of insider trades and that analyst coverage is more strongly associated with insider purchases than with insider sales. The authors also find that the positive association between analyst coverage and insider trades is less pronounced after the passage of Reg FD. Further investigations reveal that analysts revise their earnings forecasts upward following insider purchases, the informativeness of analyst forecast revisions significantly increases following insider purchases and optimistic bias in analyst forecast revisions is reduced as a result of insider purchases; the authors do not find similar evidence for insider sales.

Research limitations/implications

A large body of insider trading literature (Johnson et al., 2009; Badertscher et al., 2011; Thevenot 2012; Skaife et al., 2013; Billings and Cedergren 2015; Dechow et al., 2016) provides evidence that insiders actively trade on their private information, such as their foreknowledge of price-relevant corporate events. This literature suggests that insider trades are potentially value-relevant and are informative about a firm’s future prospects. However, less research attention has been paid to investigating how insider trades might affect market participants’ (especially sophisticated participants’) behavior. This study contributes to understanding the role that insider trading may play in shaping analyst behavior.

Practical implications

Prior research (Frankel and Li, 2004; Lustgarten and Mande, 1995; Carpenter and Remmers, 2001; Seyhun, 1990) maintains that insider sales are less informative about a firm’s future prospects than are insider purchases because insider sales might take place for the liquidity and diversification purposes. By probing the stock price responses to insider selling activities, Lakonishok and Lee (2001), Jeng et al. (2003) and Fidrmuc et al. (2006) infer that insider selling is not informative about future firm performance. However, for such an inference, the authors cannot rule out the possibility that insider sales do convey value-relevant information, but the stock market does not react correctly to such trading information (Beneish and Vargus, 2002). Because the authors focus on examining analysts’ responses to insider sales, and analysts are supposed to be sophisticated in information processing, this study adds more compelling evidence for the notion that insider sales convey less information about a firm’s future prospects than do insider purchases.

Social implications

There is an ongoing debate about the benefits and drawbacks of insider trading. Opponents of insider trading view insider trades as inequitable and immoral and assert that restricting insider trades curbs resource misallocation and benefits the whole society. Proponents contend that insider trading accelerates the price discovery process, increases market efficiency (Leland, 1992; Bernhardt et al., 1995; Choi et al., 2016) and may even play a role in rewarding and motivating executives (Roulstone, 2003; Denis and Xu, 2013). The authors add to this debate by documenting that insider trading increases the amount of information valuable to analyst research activities and helps enhance analyst services.

Originality/value

To the best of the authors’ knowledge, this study is the first to offer firm-level evidence of a positive association between insider trades and analyst coverage. By accounting for the post-Reg-FD regime, this paper is also the first to provide evidence on how analysts, in the absence of access to management’s private information because of the regime change by Reg FD, react to insider trades.

Details

Accounting Research Journal, vol. 33 no. 3
Type: Research Article
DOI: https://doi.org/10.1108/ARJ-08-2019-0148
ISSN: 1030-9616

Keywords

  • Analyst following
  • Analyst forecast properties
  • Insider purchases
  • Insider sales
  • Regulation Fair Disclosure
  • G12; G14; G24; M41; M48

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Article
Publication date: 5 March 2020

The association of analysts’ cash flow forecasts with stock recommendation profitability

Shanshan Pan and Zhaohui Randall Xu

The purpose of this paper is to examine whether analysts’ cash flow forecasts improve the profitability of their stock recommendations and whether the positive effect of…

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Abstract

Purpose

The purpose of this paper is to examine whether analysts’ cash flow forecasts improve the profitability of their stock recommendations and whether the positive effect of cash flow forecasts on analysts’ stock recommendation performance varies with firms’ earnings quality.

Design/methodology/approach

To test the authors’ predictions, they identify a sample of 161,673 stock recommendations with contemporaneous earnings forecasts and/or cash flow forecasts and regress market-adjusted stock returns on a binary variable that proxies for the issuance of cash flow forecasts while controlling for contemporaneous earnings forecast accuracy, earnings quality, analysts’ forecast experience and capability and certain firm characteristics. The authors’ test results are robust to alternative measures of recommendation profitability, earnings quality and the use of recommendation revisions instead of recommendation levels.

Findings

The authors find that when analysts issue cash flow forecasts concurrently with earnings forecasts, their stock recommendations lead to higher profitability than when they only issue earnings forecasts, after controlling for analysts’ forecast capability. Moreover, the authors document that the contemporaneous positive relationship between cash flow forecasts and recommendations profitability is stronger for firms with low earnings quality than for firms with high earnings quality. The findings suggest that cash flow forecasts issued by analysts in response to market demand likely play a more important role in firm valuation than cash flow forecasts issued by analysts mainly because of supply-side considerations.

Research limitations/implications

Future research could build on these findings to conduct further investigation on the alternative incentives for analysts’ forecasts of sales growth and long-term growth rates.

Practical implications

These findings may also help investors to better assess the quality of analysts’ research outputs and to identify superior stock recommendations.

Originality/value

This study provides insight into the role of cash flow forecasts in firm valuation and adds fresh evidence to the debate on the usefulness of cash flow forecasts. It extends the stream of research on the characteristics of analyst forecasts and increases our knowledge about the role of analysts in the financial market.

Details

International Journal of Accounting & Information Management, vol. 28 no. 2
Type: Research Article
DOI: https://doi.org/10.1108/IJAIM-05-2019-0055
ISSN: 1834-7649

Keywords

  • Earnings quality
  • Earnings forecasts
  • Analysts’ cash flow forecasts
  • Stock recommendations profitability
  • G24
  • G29
  • M41

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Article
Publication date: 5 August 2019

The impact of strategic deviance on analysts’ earnings forecasts: evidence from China

Xiqiong He and Changping Yin

The purpose of this paper is to explore the effect of firm’s deviant strategy on analysts’ earnings forecasts and further examine the effects of firm’s information…

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Abstract

Purpose

The purpose of this paper is to explore the effect of firm’s deviant strategy on analysts’ earnings forecasts and further examine the effects of firm’s information transparency and environmental uncertainty on these relationships from information asymmetry perspective.

Design/methodology/approach

The sample includes listed firms on Shanghai and Shenzhen Stock Exchange during the period 2007-2013.

Findings

The results indicate that firms’ deviant strategies have effects on analysts’ earnings forecasts, in particular, firms with extreme strategies have less analysts following, larger forecast error and dispersion compared with firms following industry norms. Moreover, information transparency and environmental uncertainty have effects on the relationship between strategic deviance and analysts’ earnings forecasts.

Practical implications

The empirical results of this paper provide strong evidence that strategy information is an important source of information for analysts’ earnings forecasts, which shows that analysts should pay attention to not only financial information but also the strategic information, especially when the information is related to strategic choice. In addition, it is necessary for investors to focus on strategic information to have a better understanding on financial information of enterprises and make better investment decisions.

Originality/value

The findings of this study indicate that corporate strategic deviance has an effect on analysts’ earnings forecasting behavior. This study enriches research studies on corporate strategy and external stakeholders and complements related research on analysts’ earnings forecasts from strategic perspective and information asymmetry perspective.

Details

Nankai Business Review International, vol. 10 no. 3
Type: Research Article
DOI: https://doi.org/10.1108/NBRI-10-2018-0060
ISSN: 2040-8749

Keywords

  • Environmental uncertainty
  • Information transparency
  • Analysts’ earnings forecasts
  • Strategic deviance

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Article
Publication date: 5 August 2019

Do management earnings forecasts fully reflect information in past earnings changes?

Guojin Gong, Yue Li and Ling Zhou

It has been widely documented that investors and analysts underreact to information in past earnings changes, a fundamental performance indicator. The purpose of this…

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Abstract

Purpose

It has been widely documented that investors and analysts underreact to information in past earnings changes, a fundamental performance indicator. The purpose of this paper is to examine whether managers’ voluntary disclosure efficiently incorporates information in past earnings changes, whether analysts recognize and fully anticipate the potential inefficiency in management forecasts and whether managers’ potential forecasting inefficiency entirely results from intentional disclosure strategies or at least partly reflects managers’ unintentional information processing biases.

Design/methodology/approach

Archival data were used to empirically test the relation between management earnings forecast errors and past earnings changes.

Findings

Results show that managers underreact to past earnings changes when projecting future earnings and analysts recognize, but fail to fully anticipate, the predictable bias associated with past earnings changes in management forecasts. Moreover, analysts appear to underreact more to past earnings changes when management forecasts exhibit greater underestimation of earnings change persistence. Further analyses suggest that the underestimation of earnings change persistence is at least partly attributable to managers’ unintentional information processing bias.

Originality/value

This study contributes to the voluntary disclosure literature by demonstrating the limitation in the informational value of management forecasts. The findings indicate that the effectiveness of voluntary disclosure in mitigating market mispricing is inherently limited by the inefficiency in management forecasts. This study can help market participants to better use management forecasts to form more accurate earnings expectations. Moreover, our evidence suggests a managerial information processing bias with respect to past earnings changes, which may affect managers' operational, investment or financing decisions.

Details

International Journal of Accounting & Information Management, vol. 27 no. 3
Type: Research Article
DOI: https://doi.org/10.1108/IJAIM-11-2017-0144
ISSN: 1834-7649

Keywords

  • Earnings persistence
  • Underreaction
  • Management earnings forecasts
  • Past earnings changes
  • G14
  • M41

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Article
Publication date: 25 November 2019

Psychology and behavioral finance: Anchoring bias by financial analysts on the Tunisian stock market

Ahmed Bouteska and Boutheina Regaieg

The purpose of this paper is to detect quantitatively the existence of anchoring bias among financial analysts on the Tunisian stock market. Both non-parametric and…

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Abstract

Purpose

The purpose of this paper is to detect quantitatively the existence of anchoring bias among financial analysts on the Tunisian stock market. Both non-parametric and parametric methods are used.

Design/methodology/approach

Two studies have been conducted over the period 2010–2014. A first analysis is non-parametric, based on observations of the sign taking by the surprise of result announcement according to the evolution of earning per share (EPS). A second analysis uses simple and multiple linear regression methods to quantify the anchor bias.

Findings

Non-parametric results show that in the majority of cases, the earning per share variations are followed by unexpected earnings surprises of the same direction, which verify the hypothesis of an anchoring bias of financial analysts to the past benefits. Parametric results confirm these first findings by testing different psychological anchors’ variables. Financial analysts are found to remain anchored to the previous benefits and carry out insufficient adjustments following the announcement of the results by the companies. There is also a tendency for an over/under-reaction in changes in forecasts. Analysts’ behavior is asymmetrical depending on the sign of the forecast changes: an over-reaction for positive prediction changes and a negative reaction for negative prediction changes.

Originality/value

The evidence provided in this paper largely validates the assumptions derived from the behavioral theory particularly the lessons learned by Kaestner (2005) and Amir and Ganzach (1998). The authors conclude that financial analysts on the Tunisian stock market suffer from anchoring, optimism, over and under-reaction biases when announcing the earnings.

Details

EuroMed Journal of Business, vol. 15 no. 1
Type: Research Article
DOI: https://doi.org/10.1108/EMJB-08-2018-0052
ISSN: 1450-2194

Keywords

  • Financial analysts
  • Tunisian stock market
  • Anchoring bias
  • Earnings per share (EPS)
  • Unexpected earnings
  • G12
  • G14
  • G17
  • M10

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Article
Publication date: 2 January 2020

Properties of analysts’ consensus cash flow forecasts for Australian firms

Kamran Ahmed, Muhammad Nurul Houqe, John Hillier and Steven Crockett

The purpose of this paper is to determine the properties of analysts’ cash flows from operations (CFO) forecast generated for Australian listed firms as a productive…

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Abstract

Purpose

The purpose of this paper is to determine the properties of analysts’ cash flows from operations (CFO) forecast generated for Australian listed firms as a productive activity, within the wider processes of financial disclosure in Australia.

Design/methodology/approach

Two categories of criteria are adopted: first, basic predictive statistical performance relative to a benchmark model and earnings forecasts; and second, relevance for equity pricing, as indicated by the market reaction to cash flow or forecast error reactions. The final sample comprised 2,138 observations between 2001 and 2016 and several regression models are estimated to determine the relative performance and market reaction.

Findings

Analysts’ consensus cash flow forecasts demonstrate poor predictive performance relative to earnings forecasts. Cash flow forecasts are typically naïve extensions of earnings forecasts. Furthermore, cash flow forecasts appear to be of minimal use for equity market participants in complementing earnings forecasts’ role in informing firms’ equity pricing.

Practical implications

While analysts’ earnings forecasts are useful for making predictions, the role of analysts’ cash flow forecasts in capital market functional efficiency appears quite limited.

Originality/value

This study is one of few that examines comparative usefulness of analysts’ earnings and cash flow forecasts and their predictive power using the Australian setting. Additionally, it enriches the sparse international literature on such forecasts.

Details

Accounting Research Journal, vol. 33 no. 1
Type: Research Article
DOI: https://doi.org/10.1108/ARJ-11-2017-0197
ISSN: 1030-9616

Keywords

  • Australia
  • Earnings forecasts
  • Forecast accuracy
  • Cash flow forecasts

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