Studying the theory of analyst self-selection regarding coverage decisions, the authors find that relatively pessimistic analysts tend to reveal their earnings forecasts later than other analysts.
On average, analysts’ longer-term earnings forecasts tend to be more optimistic than their shorter-term earnings forecasts. The authors argue that individual analysts who hold relatively pessimistic views about upcoming earnings—compared with other analysts—choose to reveal their forecasts later in the forecast period. This choice is a potential explanation for the decrease in analysts’ earnings forecast optimism over the period prior to annual earnings announcements.
How Is This Article Useful to Practitioners?
The behavior of individual analysts during the forecast period prior to earnings announcements is critical for individual and institutional investors alike. The authors study possible reasons why relatively pessimistic analysts may engage in forecast timing. Their findings extend two streams of recent research: prior studies that focus on analysts’ self-selection and coverage and recent studies that highlight the effect of the incentive to generate trading based on analysts’ forecasting behavior.
The authors conclude that the forecasts of analysts who issue their first forecast in the last 6 months prior to the annual earnings announcement date are relatively more pessimistic compared with concurrent forecasts made by analysts who start forecasting earlier in the 12-month forecast period. This type of analyst self-selection can explain a significant portion of the decrease over time in the optimistic bias in analysts’ average forecasts.
How Did the Authors Conduct This Research?
The authors use individual analyst forecast data for one-year-ahead annual earnings from the I/B/E/S Detail History database. The sample period is 1989–2010. The sample includes all individual forecasts for one-year-ahead annual earnings made in the six months prior to annual earnings announcements.
The sample also includes firm-years when there is at least one analyst who issues his or her first forecast in the last 6 months of the 12-month forecast period and at least one analyst who issues an initial forecast in the first 6 months of the 12-month forecast period and subsequently revises the forecast in the last 6 months of the 12-month forecast period prior to the annual earnings announcement date. These criteria provide a sample of 433,858 analyst firm-years for 48,955 unique firm-years. These 48,955 firm-years include observations from 9,512 unique firms and 14,240 individual analysts.
The authors find that analysts who hold relatively pessimistic views about future earnings start issuing earnings forecasts later than other analysts forecasting for the same firm-year. This forecast timing effect is more prevalent in firms that are cheaper and less risky to short sell. In addition, the analyst forecast timing effect contributes to the explanation of the decrease in the average forecast optimism over the forecast period before annual earnings announcements. The authors demonstrate that analysts’ forecast timing is stronger in the post-Regulatory FD (Fair Disclosure) period than the pre-Regulatory FD period.
The authors help increase the understanding of analysts’ forecasting behavior by showing empirically that such strategic forecast timing behaviors are associated with analysts’ incentives to generate trading commissions through short sales. The article makes a strong point as to why the number of analyst forecasts tends to increase over the forecast period prior to earnings announcements.