Do Analysts’ Long-Term Growth Forecasts Signal Effective Effort Underlying Informative Stock Recommendations and Favorable Career Outcomes?

Abstract

Prior literature finds that economic incentives related to generating investment banking business and trading commissions provide the most dominant explanation for variation in analysts’ forecasts of firms’ long-term earnings growth (LTG). Prior research evidence also indicates that relying on LTG forecasts leads to negative excess returns in subsequent periods. However, the literature also documents that analysts’ LTG forecasts explain variation in their own stock recommendations. These results beg the question as to why analysts issue and use LTG forecasts that apparently fail to enhance the value-relevance of their stock recommendations. This paper addresses that question by examining whether the issuance of LTG forecasts reflects analyst effort that does, indeed, enhance the value-relevance of their stock recommendations. We show that analysts who publish LTG forecasts provide the market with more timely stock recommendations. We also find that the stock market responds more strongly to stock recommendations and recommendation revisions accompanied by LTG forecasts issued by the same analysts. Further tests show that post- Regulation Fair Disclosure (Reg. FD) observations drive our results. Finally, we investigate the effect of LTG forecast issuance on analyst career outcomes and find evidence suggesting that analysts issuing LTG forecasts are less likely to leave the profession or move to smaller brokerage houses, particularly after Reg. FD. Overall, our results suggest that publication of LTG forecasts signals effective effort increasing the value-relevance of analysts’ recommendations and providing more job security.