Earnings Forecast Optimism Research Articles

Analyst Earnings Forecast Optimism during the COVID-19 Pandemic: Evidence from China

Analysts are important participants in the capital market, but there are relatively few studies on the impact of the COVID-19 outbreak on analysts’ behaviors. This article examines the impact of the COVID-19 outbreak on the analysts’ earnings forecast optimism by using a sample of visits to Chinese listed firms during 2019–2020. We find that the analysts’ earnings forecasts become less optimistic and show pessimism after the outbreak of COVID-19. This result is consistent with past research findings that major natural disasters lead to analysts’ forecasts pessimism. However, we also find that the earnings forecasts issued by analysts with on-site visits are more optimistic after the COVID-19 outbreak. The increase in optimism is associated with accounting information transparency, the proportion of tangible assets, and the revenue geographical concentration of the visited companies. Further analysis shows that higher optimism in visiting analysts’ earnings forecasts after the COVID-19 outbreak leads to a positive market response, suggesting that optimism in visiting analysts’ forecasts misleads the market’s resource allocation. We also find that the higher level of optimism in visiting analysts’ earnings forecasts disappeared after the COVID-19 outbreak was well controlled. Overall, our study enriches the study of the impact of COVID-19 on capital markets from the perspective of analysts’ forecast optimism. Investors in other countries should also be aware of the impact of similar phenomena.

Stock index adjustments and analysts’ forecast optimism: A quasi-natural experiment on the CSI 300 Index

As stock index adjustments comprise a basic system of capital market, their potential influence on analysts’ earnings forecasts is worthy of research. Based on a research sample of 23 adjustments to the CSI 300 Index from June 2007 to June 2018 and the backup stocks announced during the same period, this study examines the impact of additions to stock index on analysts’ forecast optimism using a staggered difference-in-differences model. The research results show that after stocks are added to the stock index, analysts’ earnings forecast optimism about these stocks increases significantly. Cross-sectional analysis indicates that this increase is more significant when the market is bullish, institutional ownership is low, the ratio of listed brokerage firms is low, star analyst coverage is low, firms show seasoned equity offering activity, the ratio of analysts from the top five brokerage firms ranked by commission income is high, and the analysts’ brokerage firms are shareholders. However, analyst-level tests find that analysts’ ability helps to reduce the impact of additions to stock index on earnings forecast optimism. Furthermore, additions to stock index significantly increase analyst coverage and forecast divergence. Economic consequences tests find additions to stock index significantly increases stock price synchronization, which is partly mediated by analysts’ earnings forecast optimism. This study enriches the literature on the impact of basic capital market systems and analyst behavior. The findings suggest that investors should rationally evaluate analysts’ earnings forecasts for stocks added to the stock index and obtain further information from various channels to improve asset allocation efficiency.

Brokerage trading volume and analysts’ earnings forecasts: a conflict of interest?

Using unique new data, we examine whether brokerage trading volume creates a conflict of interest for analysts. We find that earnings forecast optimism is associated with higher brokerage volume, even controlling for forecast and analyst quality, recommendations, and target prices. However, forecast accuracy is also significantly associated with higher volume. When analysts change brokerage houses, they bring trading volume with them, influencing trading volume at the new brokerage. This indicates that analysts drive the volume effects we observe. Consistent with a reward for generating volume, brokerage houses are less likely to demote analysts who generate more volume. Finally, analysts strategically adjust forecast optimism based on expected volume impact. Analysts become more (less) optimistic if their optimistic forecasts in the prior year were more (less) successful at generating volume. However, consistent with higher costs to increasing accuracy, analysts do not update accuracy based on expected volume impact. Overall, our results are consistent with a brokerage trading volume conflict of interest moving analysts towards more optimistic earnings forecasts, despite the volume reward for accuracy.

Does an anti-corruption campaign increase analyst earnings forecast optimism?

We examine the impact of an anti-corruption campaign on analyst earnings forecast optimism. Using hand-collected site visits data by the Central Inspection Team (CIT) in China that began in 2013, we document higher analyst optimism during CIT visit periods than during non-CIT visit periods. The results are robust to matched samples, placebo tests, alternative fixed effect and clustering specifications, endogeneity of CIT site visits concern, and alternative samples. Additional analysis suggests that local government pressure and firm bad-news-hiding explain the findings but it is not consistent with the improved firm fundamentals interpretation. Moreover, we find that the effect of CIT visits on analyst optimism is more pronounced for star, non-affiliated, and experienced analysts, supporting the notion that, because of their greater influence, local governments focus on pressuring these analysts. More important, the impact of CIT visits on analyst optimism is more salient if a CIT leader had previous work experience or longer work experience in the inspected province. Interestingly, we document a reversion in analyst earnings forecast optimism 60 days after CIT site visits, especially among the non-state-owned firms, suggesting that, after the CIT investigation, analyst optimism is no longer needed.

Investor sentiment and management earnings forecast bias

AbstractThis study investigates whether investor sentiment is associated with behavioral bias in managers’ annual earnings forecasts that are generally issued early in the year when uncertainty is relatively high. I provide evidence that management earnings forecast optimism increases with investor sentiment. Furthermore, I find that managers’ annual earnings forecasts are more pessimistic during low‐sentiment periods than during normal‐sentiment periods. Since managers lack incentives to further deflate stock prices during a low‐sentiment period, this evidence indicates that sentiment‐related management earnings forecast bias is likely to be unintentional. In addition, I find that the relationship between management earnings forecast bias and investor sentiment is stronger for firms with higher uncertainty, consistent with investor sentiment having a greater influence on management earnings forecasts when uncertainty is higher.

The effect of the European Markets in Financial Instruments Directive on affiliated analysts’ earnings forecast optimism

We investigate the effects of the European Markets in Financial Instruments Directive (MiFID) on optimism in financial analysts’ earnings forecasts for Euro Area firms. We find that before MiFID came into force affiliated analysts – that is, analysts with closer business ties to the firms they follow – issued more optimistic longer-term earnings forecasts than their more independent peers. At the same time their short-run forecasts were significantly less optimistic which is consistent with the notion of downward management of their earnings forecasts to avoid negative earnings surprises. Since the adoption of MiFID, these differences in short-term and longer-term forecasts by affiliated and non-affiliated analysts have been eliminated indicating that with respect to affiliated financial analysts’ earnings estimates MiFID has been successful in mitigating conflicts of interest.

Earnings Forecast Optimism For U.S. Vs. Non-U.S. Firms

This study examines whether financial analysts are more optimistic in their earnings forecasts for non-U.S. firms than they are for U.S. firms. Several areas of research motivate this examination. First, research shows that global economic influences, such as economic downturns and the desire to increase the international content of portfolios, encourage investors to seek out international investment opportunities in new markets. Second, literature also reveals that emerging markets provide superior growth potential; however, analyzing such firms could introduce task complexity which research finds to be associated with lower forecast accuracy. Finally, research shows that financial analysts cover firms of which they have a favorable opinion. Therefore, because of this literature, it is reasonable to expect that analysts make more optimistic forecasts (over-estimate errors) of the earnings potential of the non-U.S. firms that they choose to follow vs. U.S. firms. Using a summary level measurement of forecast optimism, the authors find that analysts forecasts are more optimistic for non-U.S. firms over both short and long-term horizons. In analyst-level tests, it was found that individual analysts produce more optimistic forecasts for non-U.S. firms in relation to their peers in the long-term; however, that optimism is reduced under short horizons. As portfolios become more internationally diversified, the result of this study will be useful to investors seeking analyst guidance about international investment opportunities.

Exploring the Accrual-Related Optimism in Management Earnings Forecasts

In this study, we examine the effect of accrual-based earnings management on the relation between managers’ earnings forecast optimism and accruals (which we label “managers’ accrual-related forecast optimism”). We build on extensive research which finds that managers inflate accruals to meet or beat earnings benchmarks and suggest that managers’ accrual-related forecast optimism can arise because managers issue optimistic forecasts in an attempt to justify inflated accruals. Consistent with expectations, we find that managers’ earnings forecast optimism is positively associated with discretionary accruals (which proxy for accrual-based earnings management) but not with nondiscretionary accruals. Furthermore, managers’ accrual-related forecast optimism is stronger when earnings management constraints are high. Finally, we find a substantial decline in managers’ accrual-related forecast optimism following the enactment of the Sarbanes-Oxley Act of 2002 which restricted managers’ use of accrual-based earnings management. Overall, our results suggest that managers’ accrual-related forecast optimism is at least in part due to intentional decisions made by managers and is not simply a product of forecasting difficulty related to accruals.

The Effect of Regulation FD on Management Earnings Forecasts

We investigate Regulation FD's effect on managers' earnings forecasts. FD's prohibition on private communication between managers and analysts alters the net benefits firms derive from public disclosure, which we hypothesize 1) simultaneously motivates some firms to stop and other firms to start providing management earnings forecasts, 2) reduces management earnings forecast optimism bias, 3) increases forecast accuracy, and 4) increases forecast informativeness. Our evidence is consistent with all four hypotheses. Thus, our evidence suggests that, although FD motivated some firms to stop forecasting, it improved most firms' forecast properties (more forecasts that are less biased, more accurate, and more informative).

Analysts’Optimism and Selection Bias

This paper is an empirical examination, drawing on the Institutional Brokers Estimate System (I/B/E/S) database, of analysts’ earnings forecast optimism for Brazilian companies. The study found that analysts were optimistic on average and performed poorly in terms of precision and accuracy. The study period was January 1995 to December 2002. The forecasting errors in one period were correlated with the errors of the following period. There was evidence of persistent consensus errors among analysts, with those who were persistently optimistic outweighing those who were persistently pessimistic. A possible explanation for this predominant overoptimism is selection bias. In order to adjust analysts’ consensus forecasts, an optimization methodology is suggested, providing results that minimize the optimism bias. The evidence presented is relevant, especially for those using analysts’ earnings forecasts as an input in their stock valuation models.

Earnings Predictability and the Direction of Analysts' Earnings Forecast Errors

Das et al. (1998) suggest that as earnings become less predictable, analysts issue increasingly optimistic forecasts to please managers and consequently gain, or at least limit the loss of, access to managers' private information. We reexamine the association between earnings forecast error and earnings predictability because there is evidence suggesting that deliberate earnings forecast optimism is not an effective mechanism for gaining access to managers' information (e.g., Eames et al. 2002; Matsumoto 2002). We document associations between earnings level and both forecast error and earnings predictability. These associations suggest that earnings level may be an important control variable when examining the association between forecast error and earnings predictability. When we control for the level of earnings we find no significant association between forecast error and earnings predictability. Thus, we find no evidence that analysts intentionally issue optimistically biased earnings forecasts.