Consistency between earnings forecasts and stock recommendations : the effect of political connections

Abstract

Financial analysts’ earnings forecasts are more consistent with stock recommendations when their earnings forecasts are more accurate (Loh and Mian 2006, Ertimur et al. 2007). This suggests that analysts use other information in their private valuation models in addition to earnings forecasts especially when earnings have greater uncertainty. Recent studies show that political connections are important for firm valuation and are associated with future positive returns and future positive operating performance (Faccio 2006, Cooper et al. 2010). In this study, I examine how a firm’s political connections affect stock recommendation informativeness as well as the efficiency with which analysts translate their earnings forecasts into stock recommendations. Using data from the Federal Election Commission through the Center for Responsive Politics from 1993 – 2011, I first show that analysts’ recommendations are less informative when firms have political connections. This relation holds for both All-Star and non-All-Star analysts, upgrade and downgrade recommendations, as well as initiation and non-initiation recommendations. Second. I show that analysts’ earnings forecast accuracy is less consistent with recommendation informativeness when firms are politically connected. This inconsistency appears to be driven by non-All-Star analysts, upgrade recommendations, and non-initiation recommendations. The findings of this study imply that political connection information is one source of important nonfinancial disclosure that influences how analysts map their earnings forecasts into stock recommendations.