The Role of Anchoring Bias in the Equity Market

Abstract

“Anchoring” describes the fact that in forming numerical estimates of uncertain quantities, adjustments in assessments away from an arbitrary initial value are often insufficient. We show that this cognitive bias has significant economic consequences for the efficiency of financial markets. We find that analysts make optimistic (pessimistic) forecasts when a firm’s forecast earnings per share (FEPS) is lower (higher) than the industry median. Further, firms with FEPS greater (lower) than the industry median experience abnormally high (low) future stock returns, particularly around subsequent earnings announcement dates. Firms with a high FEPS relative to the industry median are also more likely to engage in stock splits. Finally, split firms experience greater positive forecast revisions, larger forecast errors, and larger negative earnings surprises after a stock split compared to which did not split their stock, especially for firms with a low FEPS relative to the industry median.