Analyst reputation and management earnings forecasts

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Abstract

Prior studies show that analysts with high reputation are influential in the market. This paper examines whether managers consider analyst reputation in shaping their voluntary disclosure strategy. Using Institutional Investor magazine’s All-American (AA) rankings as a proxy for analyst reputation, we find that the coverage of AA analysts is positively associated with the likelihood of quarterly management earnings forecasts (MEFs). We also find that AA analysts’ forecast optimism is more positively associated with the likelihood of MEFs than non-AA analysts’ forecast optimism when the firm is covered by AA analysts. Analyses based on AA analyst coverage changes and AA status changes confirm the relation between analyst reputation and MEFs. We further find that analyst reputation influences other MEF properties, such as forecast news, bias, and revisions, and that our results are robust to alternative measures of analyst reputation. Further analyses show that market reactions at quarterly earnings announcements are more positive (negative) when firms meet/beat (miss) AA analysts’ forecasts than when firms meet/beat (miss) non-AA analysts’ forecasts. Collectively, our findings suggest that managers strategically provide voluntary forecasts by taking into account the reputation of individual analysts following their firms.

Introduction

This paper examines whether the reputation of individual analysts following a firm affects the firm’s voluntary disclosure practice. Despite evidence of analyst heterogeneity (e.g., Stickel, 1992, Gleason and Lee, 2003, Bonner et al., 2007, Loh and Stulz, 2011), prior studies do not recognize the possibility that managers consider analyst reputation in shaping their voluntary disclosure strategy.1 Using Institutional Investor magazine’s (II’s) All-American (AA) rankings as a proxy for analyst reputation, we examine whether the incidence and various properties of quarterly management earnings forecasts (MEFs) are associated with reputable analysts’ coverage and their forecast optimism.

MEFs, an explicit form of earnings guidance, provide information about expected earnings for a particular firm and are a key voluntary disclosure mechanism by which managers establish or alter earnings expectations in the market (Hirst et al., 2008). Although firms have long- or medium-term earnings guidance policies, not all firms that issue earnings guidance make MEFs every quarter. That is, managers have discretion to issue or skip MEFs in any given quarter.2 We examine whether managers consider analyst reputation in their disclosure decisions.

Analysts’ reputation can affect MEFs through at least two channels. First, Dye (1988) suggests that voluntary disclosure increases as the probability of market participants being informed increases. Considering that AA analysts have better forecasting ability than non-AA analysts (Stickel, 1992) and are more likely to be associated with big brokerage firms than non-AA analysts, it is reasonable to expect that AA analysts are more informed than non-AA analysts. Thus, we expect that firms followed by AA analysts are more likely to make voluntary disclosures than firms without an AA analyst following. Second, considering that analysts revise their forecasts in response to MEFs (e.g., Baginski and Hassell, 1990, Cotter et al., 2006) and that AA analysts are more influential than non-AA analysts (e.g., Park and Stice, 2000, Gleason and Lee, 2003, Loh and Stulz, 2011), managers have greater incentives to issue MEFs, because adjusting market expectations through MEFs would be more efficient when AA analysts cover the firm than when no AA analyst covers the firm.

We focus on AA status as a proxy for analyst reputation for several reasons. First, using AA status as a proxy for reputable analysts enables us to examine the effect of reputable analysts’ coverage on a firm’s disclosure decisions. Kirk et al., 2014, Zhou, 2019 use “key or influential analysts” as a proxy for reputable analysts. Key or influential analysts are defined as those who have the greatest composite score among all analysts following a firm during a quarter, where the composite score is calculated using eight analyst and forecast characteristics. Accordingly, every firm has a key or influential analyst for each quarter by design, and thus we cannot examine whether the coverage of reputable analysts influences a firm’s disclosure decision. Moreover, AA analysts are chosen by Institutional Investor magazine, and the same set of AA analysts is applied to all firms in any given year. Therefore, unlike reputable analysts defined in the Kirk et al., 2014, Zhou, 2019, the identification of reputable analysts based on AA analysts is less likely to be shaped by firm-quarter specific factors.3

Second, more importantly, the use of AA analysts enables us to conduct a test based on AA analysts’ status change. This quasi-natural experiment helps strengthen the causal interpretation of the results. A new listing in and a drop from the Institutional Investor’s AA ranking are events that change perceptions about an analyst’s reputation. The change of an analyst’s status, either from non-AA to AA or from AA to non-AA, is unlikely to be influenced by an individual firm’s disclosure practice to a large extent.

We test our empirical predictions using a sample of firm-quarters that are covered by at least one of II’s AA analysts between 2001 and 2010 and a matched sample of firm-quarters that are not covered by AA analysts. We find that firms followed by AA analysts are more likely to issue quarterly MEFs than firms not followed by AA analysts. AA analyst coverage is associated with a 5.8% increase in the likelihood of MEFs from the sample mean. We also find that firms are more likely to issue quarterly MEFs when AA analysts’ early forecasts are more optimistic. A one-standard-deviation increase in AA analysts’ forecast optimism is associated with a 13.9% increase in the likelihood of MEFs from the sample mean. Moreover, AA analysts’ forecast optimism is more positively associated with the likelihood of MEFs than non-AA analysts’ forecast optimism when the firm is covered by AA analysts. These results suggest that the coverage and forecast optimism of AA analysts have a greater influence on a firm’s voluntary disclosure practice than those of other analysts.

Our results are robust to firm fixed effects that address the concern that time-invariant unobservable firm characteristics might drive the results. Our results are also robust to alternative measures of AA analyst coverage and AA analysts’ relative forecast optimism, as well as alternative analyst forecast windows. Our inferences remain the same even if we exclude MEFs issued on or after the fiscal quarter end.4

Although the positive relation between the likelihood of MEFs and AA analyst coverage is consistent with the argument that managers shape their voluntary disclosure strategy in response to such coverage, it is possible that AA analysts increase (decrease) their coverage when firms provide more (less) forward-looking earnings information. We address this endogeneity challenge by examining the initiation and discontinuation of AA analyst coverage. We find that managers are more (less) likely to issue MEFs when AA analysts initiate (drop) coverage. We also utilize a quasi-natural experiment based on changes in an analyst’s AA status. We find that firms are more likely to issue MEFs when an analyst who has been following the firm changes her/his status from non-AA to AA. Because the same analyst has been covering the firm, the positive relation between the incidence of MEFs and the change in the analyst’s status cannot be explained by the analyst making a coverage choice in response to more forward-looking information available through MEFs.

Considering that managers determine various properties of MEFs in addition to the incidence of MEFs, we also examine a set of MEF properties, including news, bias, and revisions of management forecasts. Managers have discretion to change these properties even when firms have policies that address whether, when, and how to issue quarterly earnings guidance (Hirst et al., 2008). We find that for the sample of firms that are covered by AA analysts, the news and bias of MEFs are more negative when AA analysts’ early forecasts are more optimistic, consistent with managers’ incentive to guide AA analysts’ (and market) expectations downward. We do not observe such relations for non-AA analysts’ forecasts. We also find that managers are more likely to update MEFs issued earlier in the quarter if AA analysts’ forecasts are more optimistic, suggesting that managers have incentives to deflate AA analysts’ early forecast optimism. Although we find the same positive relation between non-AA analysts’ forecast optimism and managers’ MEF revisions, this positive relation is more pronounced for AA analysts’ forecasts than for non-AA analysts’ forecasts when the firm is covered by AA analysts. Collectively, our findings suggest that managers provide voluntary disclosures strategically by taking into account the reputation of individual analysts following their firms.

We also check to see if our findings are robust to alternative measures of analyst reputation based on analysts’ experience, the size of the brokerage firms for which they work, and the accuracy of their past forecasts. We find that the forecast optimism of more reputable analysts (i.e., analysts who have more experience, work for larger brokerage houses, or made more accurate past forecasts) has a more positive impact on the likelihood of MFEs than that of less reputable analysts. These results are largely consistent with our main findings based on AA rankings.

An underlying premise for our analysis of AA analysts’ forecast optimism is that the consequence of meeting/beating AA analysts’ forecasts is greater than that of meeting/beating non-AA analysts’ forecasts. Thus, we examine the market reaction to meeting/beating AA analyst forecasts at the quarterly earnings announcements to provide ex-post validation for this premise. While we find a premium for meeting/beating AA analyst forecasts, there is an incremental negative reaction to missing AA analyst forecasts. These results support our argument that meeting/beating reputable analysts’ forecasts has a greater consequence than meeting/beating those of other analysts, motivating managers to guide down reputable analysts’ optimistic forecasts by issuing MEFs.

Our study makes several important contributions. It adds to the voluntary disclosure literature in general and to the literature on determinants of the incidence and properties of MEFs in particular. Earlier studies find a positive association between analyst coverage and voluntary disclosure (Lang and Lundholm, 1993, Lang and Lundholm, 1996, Graham et al., 2005, Ajinkya et al., 2005). Cotter et al. (2006) find that managers are more likely to issue MEFs when analysts’ early forecasts are optimistic.5 Nagar et al. (2003) show that managers choose the frequency of MEFs strategically. Billings and Buslepp (2016) also provide evidence of strategic management guidance around insider trading activities. We extend this line of research by showing that the reputation of individual analysts covering a firm influences how managers shape their voluntary disclosure strategy.

Our study also contributes to the literature on analyst research in general and to the literature on the effect of analyst reputation (e.g., AA analysts) in particular by providing evidence on the role of analyst heterogeneity in shaping firms’ voluntary disclosure strategies. By contrast, prior studies explore the effect of analyst heterogeneity on forecast accuracy (e.g., Stickel, 1992), the price impact of analyst forecasts (e.g., Stickel, 1992, Gleason and Lee, 2003, Loh and Stulz, 2011), and investors’ evaluations of reported earnings at the time of earnings announcements (e.g., Kirk et al., 2014). We extend the concept of heterogeneity among security analysts to the “voluntary disclosure” setting.

A recent study by Zhou (2019) is closely related to our paper, but important differences exist between the two studies. Zhou (2019) defines ‘influential analysts’ following Kirk et al. (2014). As we discussed earlier, this measure does not allow one to examine how managers respond to reputable analysts’ coverage. In contrast, we examine how firms adjust their disclosure policy in response to reputable analysts’ coverage, using AA status as a measure of analyst reputation. In addition, we examine not only the incidence of management earnings forecasts but also various other properties of management earnings forecasts and provide ex-post validation that supports our main argument. Thus, while complementing Kirk et al., 2014, Zhou, 2019, our findings extend beyond the findings in these two studies.

The rest of this paper is organized as follows. In Section 2, we discuss the relevant literature and develop hypotheses. Section 3 describes the sample and research design. We present empirical results in Section 4 and additional analyses in Section 5. We conclude in Section 6.

Section snippets

Literature review and hypotheses development

Prior studies show that analysts with high reputation are more influential in the market than other analysts. Stickel (1992) finds that AA analysts’ forecasts are more accurate and that the price impacts of AA analysts’ forecast revisions are greater than those of other analysts’ forecast revisions. Park and Stice (2000) also show that market responses are stronger to forecast revisions made by analysts with better past forecasting ability than to those made by other analysts. Gleason and Lee

Sample and data

We start with the I/B/E/S details file to collect analysts’ earnings forecasts for firm-quarters in 2001–2010. We merge these data with MEF data from the Company Issued Guidelines (CIG) of Thomson Financial’s First Call Historical Database (FCHD). We begin our sample period in 2001, because Regulation Fair Disclosure (Reg. FD) was implemented in October 2000 and prior studies suggest that this regulation has a significant impact on firm disclosure practices, including MEFs (e.g., Bailey et al.,

Descriptive statistics

Panel A of Table 2 shows the descriptive statistics for the sample of 33,946 firm-quarters, 16,973 firm-quarters covered by AA analysts and their control group of firm-quarters not covered by AA analysts, matched based on the PSM procedure. All continuous variables are winsorized at the top and bottom 1% to mitigate the influence of extreme values. Managers issue quarterly MEFs in 8.6% of quarters (or 2927 quarters out of 33,946 total firm-quarters). Analysts are optimistic in their forecasts,

AA analysts’ early forecast optimism and properties of MEFs

While managers decide whether to issue MEFs in response to analysts’ forecast optimism, they also have discretion in shaping various properties of management forecasts. To provide broader insights on the effects of individual analysts’ reputation on voluntary disclosure practice, we examine the relations between AA analysts’ early forecast optimism and management forecast properties, such as news, bias, and revisions of management forecasts.30

Conclusion

Despite an abundance of evidence that analysts are not homogeneous, prior studies rarely consider the possibility that managers consider the reputation of individual analysts in their voluntary disclosure decisions. Using II’s AA rankings as a proxy for analyst reputation, this paper finds evidence that managers shape voluntary disclosure practice by taking into account the reputation of individual analysts following their firms.

We find that firms followed by AA analysts are more likely to

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    We appreciate the helpful comments and suggestions of the editor (Marco Trombetta), two anonymous reviewers, K. R. Subramanyam, Qiang Cheng, Siqi Li, Jeffrey Ng, Carrie Pan, Jenny Li Zhang (AAA meeting discussant) and workshop participants at the 2015 AAA annual meeting and Singapore Management University.

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