Analyst Forecast Dispersion Research Articles

The European Market Abuse Directive: Has it Worked?

AbstractIn this paper, we examine whether the Market Abuse Directive (MAD) has been effective in achieving its objectives of deterring the market manipulation activities, increasing the timeliness of information and decreasing the disclosure of inside information to select groups. Our sample consists of firms listed on Frankfurt Stock Exchange. We use stock prices and analysts' forecast‐based proxies to examine the impact and effectiveness of MAD. The analysis based on these two set of proxies provides evidence that the adoption of MAD has been effective. In particular, we find that after the implementation of MAD, on average, (1) the volatility of stock prices around earnings announcement declines, (2) stock prices remain closer to their post earnings announcement level during the period before earnings announcement, (3) the accuracy of analyst forecasts improves, (4) the dispersion of analyst forecasts decreases, and (5) the number of analysts following a company declines.

Is There a Relation Between Residual Audit Fees and Analysts’ Forecasts?

We examine the relationship between residual audit fees and the ability to predict future earnings. Recent research suggests that residual audit fees contain information about accounting quality. However, residual audit fees could either represent high accounting quality or a risk premium for low accounting quality. We extend this literature by providing evidence that residual audit fees are indicative of a lower quality information environment which has a negative impact on investors’ ability to anticipate future earnings. Specifically, we first show that residual audit fees are negatively associated with the ability of current earnings to predict future earnings. Furthermore, residual audit fees are negatively associated with analyst forecast accuracy and positively associated with the dispersion in analyst forecasts. Overall, our results are consistent with the notion that residual audit fees are indicative of poor earnings quality, and that this lower quality manifests itself in a lower quality information environment for investors and analysts.

Option Return Predictability

The cross-section of delta-hedged equity option returns can be predicted by a variety of underlying stock characteristics and firm fundamentals including idiosyncratic volatility, past stock returns, profitability, cash holding, new share issuance, and dispersion of analyst forecasts, although they do not significantly predict stock returns in our sample. We document new option portfolio strategies that are profitable even after transaction costs. These profits are robust and cannot be explained by common risk factors. The systematic patterns in the relative valuation of options and the underlying stocks we uncover have important implications for option pricing models and option market efficiency.

Does a firm’s exposure to ethical failures matter to financial markets? A governance perspective

This paper investigates if a firm’s ethical reputation, in conjunction with its governance, affects its standing within financial markets. A firm`s ethical reputation, as measured by ethical failures, arises from its involvement in ethical violations and incidents while a comprehensive index proxies for governance. We assess a firm’s standing within financial markets through two complementary perspectives, i.e., the level of information asymmetry between managers and investors, as inferred from analyst forecast dispersion and analyst forecast error, and the relation between a firm’s earnings and its stock market valuation or return (value relevance). Our results suggest that a firm`s ethical reputation affects financial analysts’ forecasts as well as the stock market value assigned to its reported earnings. Moreover, it appears that corporate governance moderates such relations, with strong (weak) governance compensating for a weak (strong) ethical reputation. Overall, our evidence shows that ethical failures do not seem to pay.

Chipping Away at Financial Reporting Quality

Chief financial officers are responsible for managing the financial reporting process. We test whether the quality of a firm’s financial reports is a function of the effort expended by the CFO. Using golfing records to measure leisure consumption, we first show that CFOs consume more leisure when they have lower economic incentives. We show further that high levels of leisure consumption by CFOs are associated with lower financial reporting quality. These results hold when using firm fixed effects and when using weather quality as an instrument for the amount of golf play, suggesting that the relationship is causal. Higher levels of leisure consumption are also associated with shorter conference calls with a more uncertain tone, suggesting that the qualitative content of firms’ communications also suffers when CFOs consume high levels of leisure. Finally, the effects of lower quality reporting are demonstrated by results linking CFO leisure with greater analyst forecast dispersion and weaker earnings response coefficients.

A New Measure of Disclosure Quality: The Level of Disaggregation of Accounting Data in Annual Reports

ABSTRACTWe construct a new, parsimonious, measure of disclosure quality—disaggregation quality (DQ)—and offer validation tests. DQ captures the level of disaggregation of accounting data through a count of nonmissing Compustat line items, and reflects the extent of details in firms’ annual reports. Conceptually, DQ differs from existing disclosure measures in that it captures the “fineness” of data and is based on a comprehensive set of accounting line items in annual reports. Unlike existing measures, which are usually applicable for a subset of firms or are based on a subset of information items, DQ can be generated for the universe of Compustat industrial firms. We conduct three sets of validation tests by examining DQ's association with variables predicted by prior literature to be associated with information quality. DQ is negatively (positively) associated with analyst forecast dispersion (accuracy) and negatively associated with bid‐ask spreads and cost of equity. These associations continue to hold after we control for firm fundamentals. Taken together, results from this battery of validation tests are consistent with our measure capturing disclosure quality.

Fair value accounting of financial assets and analyst forecasts

We examine how listed firms’ financial asset holdings affect analyst forecasts. Using China A-share firms over the period 2009–2011, we find that (1) listed firms sell available-for-sale securities (AFS) to meet or beat analyst forecasts, and (2) that when firms hold AFS, their analyst forecasts are more accurate, less biased and less dispersed. However, whether firms hold trading securities (TS) has no significant effect on either analyst forecast accuracy or forecast dispersion. Further examination indicates that listed firms use AFS to manipulate earnings, and that outside governance by the financial market and legal environment cannot moderate this opportunistic behaviour. Finally, our empirical results show that analysts can see through firms’ earnings management in selling AFS. Thus, our results suggest that standard setters should consider managers’ opportunistic behaviour in derecognising financial assets.

INCORPORATION CHOICE AND IMPLIED COST OF EQUITY

Prior studies document a Delaware incorporation effect on firm valuation, generally using Tobin’s Q, but the directional effects are mixed and inconclusive. Our study uses implied cost of equity to assess valuation, and we find consistent evidence that firms incorporated outside of their home state, either in Delaware or in other states, have a cost of equity that is 40 to 100 basis points higher than firms incorporated in their home state (depending on the model). Importantly, there is no statistical difference between Delaware incorporation and other non-home states of incorporation, which suggest the more important distinction is home state versus non-home state, rather than a Delaware effect. These findings are robust to controls for risk factors that affect the cost of equity including market beta, market value of equity, book to market ratio, analyst forecast dispersion, long-term growth in earnings, and industry membership. Results are consistent in yearly estimations for the sample period 1990-2006, and robust across the spectrum of firm size, different measures of cost of equity, and to control for endogeneity of the firms’ incorporation choice.

Compensation Duration and Risk Taking

Short-termism'' of executives has recently attracted a lot of public attention. This paper develops a novel measure of CEO compensation duration and studies how it affects corporate risk taking. This measure is constructed using grant-level data of CEO compensation and reflects vesting schedules for stock grants and expiration dates for option grants. I use grants awarded many years before the measurement period as an exogenous component of compensation duration. The results show that longer pay duration is associated with higher firm risk, measured by stock return volatility, idiosyncratic stock return volatility, and analyst forecast dispersion. Additional tests show that higher risk is not associated with higher level of investment or with higher financial leverage. At the same time, higher pay duration increases the amount of equity financing and reduces earnings manipulation.

Did Analyst Forecast Accuracy and Dispersion Improve after 2002 Following the Increase in Regulation?

This article examines the accuracy and dispersion of analyst earnings forecasts from October 1993 to September 2013. The authors found an improvement in these forecast properties in the short run following various regulations in the early 2000s. Over the extended period, however, forecast accuracy significantly declined and dispersion significantly increased. The results are robust to various sensitivity tests and indicate that these regulations did not collectively improve the information environment despite the reduction in analyst conflicts of interest. The problem seems to be largely due to the quality of financial reports.

The Information Environment and Borrowing Costs in International Bond Markets

We examine whether and how a firm's information environment – as characterized by earnings quality, analyst forecast dispersion, and the probability of informed trading – affects its borrowing costs in international bond markets. Using a sample of Eurobonds issued by firms across 38 countries, we find that bonds issued by firms with poor information environments are associated with higher costs of debt, lower credit ratings, greater probability of split bond ratings, and higher underwriting fees. Thus, we demonstrate that the information environment plays a crucial role in determining borrowing costs in international bond markets.

Firm websites and the risk of firm

Purpose – Websites have become an important channel for firms to communicate with their stakeholders. Higher web site traffic could represent effective information disclosure and higher investor recognition. Both may reduce the risk of firm by reducing the level of information asymmetry and facilitating a more complete market by reaching to more potential investors. The purpose of this paper is to investigate the impact of firm web site traffic to the risk of firm. Design/methodology/approach – The authors conducted a cross-sectional study on the risk and firm web site traffic data of 4,122 US public firms. Findings – After controlling for confounding factors, web site traffic is significantly negatively associated with three firm risk measures: cost of equity, return volatility, and analyst forecast dispersion. Originality/value – The results provide new insights to the economic impact of web site traffic. Compared with previous studies that mostly investigated the relationships between web site traffic and firm performance measured by stock returns or company profitability, the authors documented empirical evidence that web site traffic influences the risk of firm through the level of information asymmetry and investor recognition. This paper suggests that when valuing a firm, investors would take web site traffic into consideration. Firm managers could use firm Websites as a channel to reduce information asymmetry, and increase investor recognition that can contribute to the firm’s value through reduced risk.

Accounting Comparability and Earnings Attributes

We specify measures of accounting consistency both across time and across firms based on the textual similarity of accounting policy footnotes disclosed in 10-K filings. We first examine how these measures relate to earnings quality. Accounting consistency over time is positively associated with a number of earnings quality proxies, including earnings persistence, predictability, accrual quality, and absolute discretionary accruals. We also find that lower consistency relative to other firms in the industry is associated with larger absolute accrual model residuals. Finally, we examine the information processing effects of accounting consistency. We find that greater accounting consistency in the time-series and the cross-section is associated with lower information asymmetry, as proxied by bid-ask spread and illiquidity. Greater cross-sectional consistency is also associated with greater analyst coverage, more accurate analyst forecasts, decreased dispersion in analyst forecasts, and stronger stock return synchronicity.

The Earnings Quality and Information Processing Effects of Accounting Consistency

ABSTRACTWe specify measures of accounting consistency both across time and across firms based on the textual similarity of accounting policy footnotes disclosed in 10-K filings. We first examine how these measures relate to earnings quality. Accounting consistency over time is positively associated with a number of earnings quality proxies, including earnings persistence, predictability, accrual quality, and absolute discretionary accruals. We also find that lower consistency relative to other firms in the industry is associated with larger absolute accrual model residuals. Finally, we examine the information processing effects of accounting consistency. We find that greater accounting consistency in the time-series and the cross-section is associated with lower information asymmetry, as proxied by bid-ask spread and illiquidity. Greater cross-sectional consistency is also associated with greater analyst coverage, more accurate analyst forecasts, decreased dispersion in analyst forecasts, and stronger stock return synchronicity.Data Availability: The accounting consistency measures developed in this study are available upon request. All other data are available from the sources cited in the text.JEL Classifications: M41.

Goodwill Impairment Charges and Analyst Forecast Properties

SYNOPSIS We examine the association between goodwill impairment charges and analysts' forecast accuracy and dispersion. We compare a test sample of firm-quarters with reported goodwill impairment charges during 2003–2007, and two control samples (matched on propensity scores and performance) of firm-quarters that do not report impairment charges. We find that analysts' forecasts are less accurate and more dispersed for the impairment sample than for the control samples. The magnitude of impairment charges is also negatively associated with forecast accuracy and positively associated with forecast dispersion. However, two forms of monitoring, auditor industry specialization and institutional ownership, reduce the adverse effect of goodwill impairments on analyst forecast dispersion. JEL Classifications: G14; M41; M44

Do Accounting Standards Matter for Firm Productivity? Evidence from Mandatory IFRS Adoption

In this paper, we examine whether productivity improves after mandatory IFRS adoption. Using data envelopment analysis (DEA) to measure firm-level productivity, we show that production efficiency of mandatory IFRS adopters increases significantly after mandatory adoption of IFRS. The post-adoption production efficiency improves more for firms located in countries with large GAAP differences, firms exhibiting a decrease in stock return volatility and analyst forecast dispersion, and firms experiencing a large increase in the number of comparable industry peers. Taken together, the evidence suggests that firms with significant improvements in information environment from mandatory IFRS adoption are able to increase productivity substantially.

Options-implied variance and future stock returns

Using options-implied variance, a forward-looking measure of conditional variance, we revisit the debate on the idiosyncratic risk-return relation. In both cross-sectional (for individual stocks) and time-series (for the market index) regressions, we find a negative relation between options-implied variance and future stock returns. Consistent with Miller’s (1977) divergence of opinion hypothesis, the negative relation gets stronger (1) for stocks with more stringent short-sale constraints or (2) when shorting stocks becomes more difficult. Moreover, the negative correlation of realized idiosyncratic variance or analyst forecast dispersion with future stock returns mainly reflects their close correlation with our conditional idiosyncratic variance measure.

Corporate governance and the information environment: Evidence from Chinese stock markets

This article explores the relationship between corporate governance and the information environment in Chinese stock markets. We construct a parsimonious governance measure for public firms using a 2003 through 2011 sample period. We use four indicators to proxy for the information environment: analyst following, analyst forecast accuracy, analyst forecast dispersion, and price timeliness. We find that better governed firms tend to be associated with larger analyst followings and more informative forecasts. We also find that better governed firms tend to improve on the timeliness of bad news relative to good news.

Information Asymmetry and the Market Response to Open Market Share Repurchases

This paper relates informed repurchases to firm information asymmetry. We propose a new measure of informed repurchases, which is based on causality tests relating repurchase information to firm returns. Our results indicate that informed repurchases show larger abnormal returns surrounding the announcement of an open market share repurchase, which suggests the market at least partially recognizes informed repurchases. This holds after controlling for conventional information asymmetry proxies, such as firm size, number of analysts following, and analyst forecast dispersion, indicating that the market is aware of repurchase specific information not captured by traditional information asymmetry proxies. Informed repurchases demonstrate larger long-term abnormal returns at one, two, and three-year windows than high traditional information asymmetry repurchases.

Does uncertainty boost overconfidence? The case of financial analysts' forecasts

Purpose – This article aims to examine the link between uncertainty and analysts' reaction to earnings announcements for a sample of European firms during the period 1997-2007. In the same way as Daniel et al., the authors posit that overconfidence leads to an overreaction to private information followed by an underreaction when the information becomes public. Design/methodology/approach – In this study, the authors test analysts' overconfidence through the overreaction preceding a public announcement followed by an underreaction after the announcement. If overconfidence occurs, over- and underreactions should be, respectively, observed before and after the public announcement. If uncertainty boosts overconfidence, the authors predict that these two combined misreactions should be stronger when uncertainty is higher. Uncertainty is defined according to technology intensity, and separate two types of firms: high-tech or low-tech. The authors use a sample of European firms during the period 1997-2007. Findings – The results support the overconfidence hypothesis. The authors jointly observe the two phenomena of under- and overreaction. Overreaction occurs when the information has not yet been made public and disappears just after public release. The results also show that both effects are more important for the high-tech subsample. For robustness, the authors sort the sample using analyst forecast dispersion as a proxy for uncertainty and obtain similar results. The authors also document that the high-tech stocks crash in 2000-2001 moderated the overconfidence of analysts, which then strongly declined during the post-crash period. Originality/value – This study offers interesting insights in two ways. First, in the area of financial markets, it provides a test of a major over- and underreaction model and implements it to analysts' reactions through their revisions (versus investors' reactions through stock returns). Second, in a broader way, it deals with the link between uncertainty and biases. The results are consistent with the experimental evidence and extend it to a cross-sectional analysis that reinforces it as pointed out by Kumar.