Analyst Pessimism and Forecast Timing

Orie E Barron,Lihong Liang,Donal Byard

doi:10.1111/jbfa.12031

Orie E Barron, Lihong Liang + Show 1 more

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https://doi.org/10.1111/jbfa.12031

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Abstract

AbstractIn this study, we show that on average relatively pessimistic analysts tend to reveal their earnings forecasts later than other analysts. Further, we find this forecast timing effect explains a substantial proportion of the well‐known decrease in consensus analyst forecast optimism over the forecast period prior to earnings announcements, which helps explain why analysts’ longer term earnings forecasts are more optimistically biased than their shorter term forecasts. We extend the theory of analyst self‐selection regarding their coverage decisions to argue that analysts with a relatively pessimistic view–compared to other analysts–are more reluctant to issue their earnings forecasts, with the result that they tend to defer revealing their earnings forecasts until later in the forecasting period than other analysts.

Highlights

IntroductionAnalysts’ longer-term earnings forecasts tend to be more optimistic than analysts’ shorter-term earnings forecasts (e.g., see O’Brien 1988; Brown 1997)
On average, analysts’ longer-term earnings forecasts tend to be more optimistic than analysts’ shorter-term earnings forecasts
Over our sample period (1989 to 2010) we find that approximately 40% of the typical decrease in average forecast optimism over the 12-month forecast period prior to annual earnings announcements is due to relatively pessimistic analysts forecasting later in the forecast period; this increases to 50% in the post Regulation Fair Disclosure (Reg FD) period

Summary

Introduction

Analysts’ longer-term earnings forecasts tend to be more optimistic than analysts’ shorter-term earnings forecasts (e.g., see O’Brien 1988; Brown 1997). Our research question is motivated by McNichols and O’Brien’s (1997) and Hayes’ (1998) research regarding analyst self-selection They distinguish between ex ante and ex post optimism. McNichols and O’Brien (1997) argue that the observed ex post optimistic bias in analysts’ earnings forecasts (relative to actual earnings) results from analysts’ self-selection of the firms they follow: analysts drop coverage of the firms they are relatively pessimistic about compared to the other firms they follow. Analysts decide which firms to follow based upon their ex ante level of optimism: analysts compare their beliefs about a firm with their beliefs about other firms and drop coverage of firms they are relatively pessimistic about compared to the other firms they follow In this setting, analysts’ coverage decisions depend upon a benchmark that is known to analysts their beliefs about other firms, and not the (unknown) future actual earnings. We argue that rather than completely dropping coverage of a firm, analysts with a relatively pessimistic outlook compared to other analysts who follow the same firm may be more reluctant to issue forecasts, with the result that they tend to reveal their forecasts later than other analysts forecasting the same earnings

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