Alternative evidence on financial analysts' use of financial statement information

Abstract

PurposeFinancial analysts are frequently viewed as information intermediaries who process and interpret firms' financial reports for other market participants. Much recent research, however, has cast doubts on analysts' ability to fully utilize the information in firms' financial reports. Using an alternative approach, this study aims to provide evidence on how sophisticated analysts are at using information in firms' financial reports.Design/methodology/approachThe paper estimates different measures of firms' operational efficiency, all of which are derived from financial statement data, and compares the strength of the association between these measures and analysts' absolute forecast errors. It then compares a sophisticated frontier‐based measure of firms' operational efficiency that evaluates firms' performance relative to their competitors with three more traditional efficiency measures; specifically the return on asset (ROA) ratio, industry‐adjusted ROA, and the return on equity ratio.FindingsThe results indicate that the more sophisticated frontier‐based measure is more strongly negatively associated with analysts' absolute forecast errors than the other three measures. The results thus suggest that analysts are capable of undertaking a sophisticated analysis of the information in firms' financial reports, at least as it pertains to operational efficiency.Originality/valueTo the extent that analysts serve as a key group of users of financial information, these results are likely to be of interest to accounting policy makers.