Earnings Surprises that Motivate Analysts to Reduce Average Forecast Error

Abstract

Large earnings surprises and negative earnings surprises represent more egregious errors in analysts' earnings forecasts. We find evidence consistent with our expectation that egregious forecast errors motivate analysts to work harder to develop or acquire relatively more private information in an effort to avoid future forecasting failures. Specifically, we find that after large or negative earnings surprises there is a greater reduction in the error in individual analysts' forecasts of future earnings, and these individual forecasts are based more heavily on individual analysts' private information. This increased reliance on private information reduces the error in the mean forecast of upcoming earnings (even after controlling for the effect of reduced error in individual forecasts). As reliance on private information increases, more of each individual forecast error is idiosyncratic, and thus averaged out in the computation of the mean forecast.

Fair value accounting: information or confusion for financial markets?

“…We control for a bank's financial strength by including its level of Tier 1 capital (Tier 1) and for bank type using a dummy variably that is equal to 1 if the bank is a financial holding company and 0 if it is a bank holding company (Financial). We also control for a bank's size (Size) using the natural logarithm of total assets (Barron et al 2008) and bank's performance using the return on equity ratio (ROE). To control for earnings surprises, we include ΔEarnings , which is measured as the earnings at time t minus earning at time t-1 over earning at time t-1.…”

The effect of financial statement comparability on analysts’ reliance on common information

“…The authors interpreted these results to mean that earnings announcements play the role of triggering the production of private information by sophisticated users such as analysts. Barron et al(2008) investigated the effect of large earnings surprises and negative earnings surprises on analysts' reliance on common information. Their analyses showed that after a large earnings surprise or a negative earnings surprise, analysts' forecast bias is substantially reduced and their reliance on private information increases.…”

“…To test Hypothesis 1, we estimate the following OLS regression: Equation (6) is based on Barron et al(2008). The dependent variable, ρ , refers to the analyst's reliance on common information.…”

“…If the overall number of analysts following is high, analysts will reduce their reliance on common information since it is difficult to differentiate by using common information alone (Barron et al 2008). Analysts are also likely to reduce their reliance on common information for the firms with larger size, because firm size is positively related to the investors' returns from private information based trading (Atiase 1985;Byard 1998;Barron et al 2008). When accruals quality is high, investors can be provided with common information of high quality, then analysts are likely to decrease their dependence on common 10) In equation 6, we use BKLS consensus as a dependent variable.…”

The influence of disclosure policy on analyst behavior: The case of segment data

“…However, to the extent that these firm-specific factors reduce the quality (or precision) of commonly available information, investors' demand for analyst-provided information is expected to shift outward, thereby increasing equilibrium supply. Under the assumption that an analyst is interested in maximizing her expected utility, she will invest effort to generate idiosyncratic information to satisfy investors' demand, up to the point where her marginal costs of generating idiosyncratic information equal the marginal benefits of providing such information to investors (see Barron, Byard, & Yu, 2008;Barth, Kasznik, & McNichols, 2001;Das, Levine, & Sivaramakrishnan, 1998;Djatej, Gao, Sarikas, & Senteney, 2009;O'Brien & Bhushan, 1990). The next section discusses prior studies examining the relationship between corporate disclosure and analysts' efforts.…”