The Earnings Expectations Game and the Dispersion Anomaly

This study examines the role of differences in firms’ propensity to meet earnings expectations in explaining why firms with high analyst forecast dispersion experience relatively low future stock returns. We first demonstrate that the negative relation between dispersion and returns is concentrated around earnings announcements. Next, we show that this relation disappears when we control for ex ante measures of firms’ propensity to meet earnings expectations and that the component of dispersion explained by these measures drives the return predictability of dispersion. We further demonstrate that firms with low analyst dispersion are substantially more likely to achieve positive earnings surprises and provide new evidence consistent with both expectations management and strategic forecast pessimism explaining this result. Overall, we conclude that investor mispricing of firms’ participation in the earnings-expectations game provides a viable explanation for the dispersion anomaly. Accepted by Brian Bushee, accounting.

Political Patronage, Audit Quality and the Properties of Analysts' Earnings Forecasts in Malaysia

Based on a sample of 2,034 Malaysian listed firm-year observations for the period 2007-2014, this study shows a negative relationship between dimensions of political patronage (i.e., politically connected firms and the percentage of Bumiputera directors) and analysts' earnings forecast accuracy. Furthermore, the study documents a positive relationship between Bumiputera directors and earnings forecast dispersion. These results suggest that the political patronage of firms is associated with low-quality earnings. We also find that measures of high audit quality are associated with high financial reporting quality and that this is evident in firms with high audit quality showing a weaker negative (positive) relationship between forecast accuracy (dispersion) and political connections and high levels of Bumiputera directors. Overall, the findings suggest that high audit quality plays an important role in mitigating agency costs of information asymmetry by improving the financial information environment.

Analyst Forecast Dispersion and Market Return Predictability: Does Conditional Equity Premium Play a Role?

Prior studies found that analyst forecast dispersion predicts future market returns. Some prior studies attribute this predictability to the short-sale constraints in the market according to the overpricing theory. Using the U.S. data from 1981 to 2014, we find that the return predictive power of aggregate dispersion only exists prior to 2005. The investor sentiment index, as a proxy of short-sale constraints used by many studies, can only explain the dispersion effect prior to 2005. The investor sentiment index and other proxies such as institutional ownership and put options cannot explain the significant weakening of the dispersion effect after the global financial crisis. We argue that the dispersion-return relation is partly driven by the correlation between dispersion and conditional equity premium. Our evidence suggests that the short-sale constrained stocks do not experience a higher dispersion effect, which is contrary to what the overpricing theory predicts.

Does analyst forecast dispersion represent investors’ perceived uncertainty toward earnings?

Purpose This paper aims to investigate the association between analyst forecast dispersion and investors’ perceived uncertainty toward earnings. Design/methodology/approach A new measure for investors’ expectations of earnings announcement uncertainty is constructed, using changes in implied volatility of option contracts prior to earnings announcements. Unlike other proxies of uncertainty, this measure isolates the incremental uncertainty regarding the upcoming earnings announcement and is a forward-looking measure. Findings Using this new proxy, this paper finds a significant negative correlation between analyst forecast dispersion and investors’ uncertainty regarding the upcoming earnings announcements. Further tests show that this negative correlation is driven by analysts’ private information acquisition rather than analysts; uncertainty toward upcoming earnings announcements. Additional cross-sectional tests show that this negative relationship is more pronounced in the subsample with lower earnings quality. Social implications This paper helps to further the understanding of the information content of analyst forecast dispersion, particularly the ways in which they gather and produce private information and their incentives for so doing. Originality/value This paper introduces a new market-based and forward-looking proxy of earnings announcement uncertainty that should be useful in future research. This paper also provides original empirical evidence that analysts gather and produce an additional private information to the market when facing noisy signals and that their information reduces investors’ uncertainty toward upcoming earnings announcements.

Does Auditor Industry Specialization Increase Analysts’ Forecast Accuracy? Evidence from the Listed Firms of Australia

This paper examines the relation between auditor industry specialization and analysts’ beginning-of-the-year earnings forecast accuracy. It predicts that the higher industry specialization of the auditors will improve the quality of external financial reports and thus mitigates the analysts’ forecast error. It also predicts that higher audit quality will have a negative association with analyst forecast dispersion. The empirical test results on Australian listed firms from the year 2003 to 2012 does not find evidence of association between audit firm industry specialization and analysts’ beginning-of the year earnings forecast error. However, firms with higher analysts forecast error is associated with lower forecast dispersion among analysts, which is consistent with the prediction that analysts are consistent with predicting future earnings and analysts possess similar traits in terms of difference with the actual earnings. Additional analysis also finds that’s larger firms have less forecast errors compared to smaller firms. The findings contribute to the growing literature on auditing and financial reporting quality in Australian context.

Earnings informativeness in dual-class firms

Purpose The purpose of this study is to explain the poor informativeness of earnings in dual-class firms by examining the quality of earnings and the information environment. Design/methodology/approach The earnings informativeness, earnings quality and information environment of dual-class firms are compared with a matched sample of single-class firms. The authors have performed the returns-earnings association tests, examine the quality of earnings by using proxies for discretionary accruals, and examine the information environment by employing four empirical constructs: the analyst forecast dispersion, absolute forecast errors, Amihud’s (2002) illiquidity measure, and the bid-ask spread. Findings The results show that the quality of earnings is better while the quality of the information environment is worse in dual-class firms compared to single-class firms. Overall, the results suggest that an inferior information environment is a plausible explanation for the low informativeness of dual-class firms’ earnings. Research limitations/implications The results provide empirical support for Dechow et al. (2010) that the use of the earnings-returns association measure to draw conclusions about the quality of earnings is not appropriate in the presence of a poor information environment. Originality/value This is the first study to empirically show that low earnings informativeness in dual-class firms can be explained by the inferior quality of the information environment.