Analyst Forecast Inefficiency in Reaction to Earnings News: Cognitive Bias vs. Economic Incentives

Description

This project attempts to examine whether analysts' optimism and seemingly inefficient reactions to earnings news in their initial earnings forecasts after the release of prior-year earnings news are driven by their cognitive bias and/or economic incentives. The investigators further discriminate between analysts' management relation incentives that drive analysts to cultivate good relations with managers in exchange for the private information, from their investment banking and trade-boosting incentives to promote the lucrative business of their employer.The research team's preliminary results, using I/B/E/S for a period of 2000 to 2001, find that analysts' initial forecasts after earnings announcement are optimistic and analysts overreact (underreact) to good (bad) news in prior-year earnings changes. They further test whether analysts' earnings forecasts are more optimistic and analysts' inefficient reactions to different states of earnings news become more pronounced as information uncertainty increases. If more pronounced optimistic behaviour is found with higher information uncertainty, these findings will be more consistent with the management relation incentive explanation and less consistent with the investment banking incentive explanation. Furthermore, if similar results are found using I/B/E/S and Value Line analysts’ forecasts, it will further reinforce the management relation incentive interpretation of the findings.