0 оценок0% нашли этот документ полезным (0 голосов)

9 просмотров26 страницcapital earnings concept explained

Apr 09, 2015

© © All Rights Reserved

PDF, TXT или читайте онлайн в Scribd

capital earnings concept explained

© All Rights Reserved

0 оценок0% нашли этот документ полезным (0 голосов)

9 просмотров26 страницcapital earnings concept explained

© All Rights Reserved

Вы находитесь на странице: 1из 26

Journal

016Y-207O/Y3/$06.00

9 ( 1993) 295-320

of Forecasting

@ 1093 Elsevicr Science Publishers

20s

B.V. All rights

reserved

for capital markets research*

Lawrence

its implications

D. Brown

State University

of New

York

at Buffalo,

Buffalo,

NY

14260-4000,

USA

Abstract

Since the early 198Os, earnings forecasting

research has become much more closely aligned with

capital markets research.

Capital markets research requires a proxy for the (unobservable)

market

earnings

expectation

and earnings forecasting

research has provided such proxy measures.

Questions

considered

in this paper include: (1) if annual earnings follow a random walk or an IMA (1 ,I) model,

does this mean that earnings

changes cannot be predicted?

(2) Do stock prices act as if quarterly

earnings follow a seasonal random walk with drift process? (3) Is the predictive mode1 which is best on

the forecast accuracy dimension

also best on the market association

dimension?

(4) How do analysts

formulate

their earnings expectations?

(5) What is the role of earnings forecasting in earnings response

coefficient

and post-earnings

announcement

drift studies? (6) What is the likely role of earnings

forecasting

research in future capital market studies?

Keywords: Earnings

forecasting;

drift; Future research

Forecast

accuracy;

1. Introduction

When Paul Griffin and I issued a call for

papers for the Special Issue on Accounting

and

Finance

of the Journal of Forecasting

[Brown

and Griffin (1983)], most of the papers we received were concerned

about whether

annual

earnings follow a random walk (or random walk

with drift) process. Nevertheless,

this issue was

pretty much resolved

by the late 1970s. Little

(1962) provided evidence that British firms annual earnings follow a random walk process and

several

studies

of US firms [Ball and Watts

*Earlier versions of this paper were presented

at Columbia

University.

SUNY at Buffalo and the University of Waterloo.

I am grateful for the valuable comments

of Paul AndrC. Eli

Bartov, Sasson Bar-Yosef,

M. Daniel Ben&h,

Dan Coggin,

Robert Fildes, Bob Hagerman.

Jerry C. Y. Han, Tom Lechncr, John OHanlon,

Wonsun

Paek, Gordon

Richardson,

Kevin Sachs, Jake Thomas and Mark Zmijewski.

Market

association;

Post-earnings

announcement

(1972), Albrecht

et al. (1977), Watts and Leftwith (1977)] showed that Box-Jenkins

(1976)

autoregressive

integrated

moving

average

(ARIMA)

models confined

to annual

earnings

data did not generate more accurate forecasts. in

a holdout period, than those based on a random

walk model. While the papers published

in the

special issue did not focus on whether

annual

earnings follow a random walk (or random walk

with drift) process, most did focus on earnings

forecasting

and lacked implications

for capital

markets research.

A major change in the earnings forecasting

literature

took place in the

1980s; it became much more closely linked with

capital markets research.

Prior to Foster (1977), the earnings forecasting

literature

focused

on predictive

ability

and

evaluated

earnings expectation

models solely on

their ability to forecast future earnings

(hereafter, accuracy). Foster introduced

an alternative

way to evaluate

earnings

expectation

models,

namely contemporaneous

market association

of

abnormal

returns with earnings

surprise,

conditional upon the expectation

model. (Hereafter,

we shall refer to Fosters method as the association approach.)

He argued that. given the maintained

hypothesis

of an efficient

market,

the

strength of association

between abnormal returns

and earnings

surprise

indicates

how accurately

the model captures

the markets

expectation.

Since the capital markets

literature

requires

a

proxy for the markets earnings expectation.

the

association

approach made the earnings forecasting literature

important

for capital markets research. especially

when abnormal

returns were

measured

over a narrow window,

such as the

-day

period,

(-I .O), where

Day 0 is the

announcement

day [Foster ( I977)].

In an informationally

efficient market. ignoring transactions

costs and costs of generating

and

processing

information,

the association

and predictive ability approaches

should provide similar

results. The argument

that predictive ability and

association

arc two sides of the same coin is

based on the assumption

that the capital market

uses the best data available.

where best is defined as most accurate. This notion is similar to

the rational

expectations

principle

which maintains that the subjective

probability

distribution

of outcomes

is distributed

as the objective probability distribution

of outcomes

[Muth (1961 )].

In the early l%Os, researchers

began to use

the dual criteria of accuracy and association

to

evaluate

earnings forecasting

models. Fried and

Givoly (19X2) and Brown et al. (1%7a,b),

respectively.

used these same dual criteria to compare analysts

annual

and quarterly

earnings

forecasts

with those of univariate

time-series

models.

These

studies

showed

that analysts

earnings forecasts are better than those of timcseries models when both criteria are used and

suggested that analysts earnings forecasts should

be used in lieu of time-series

model forecasts,

when a proxy for the markets earnings cxpectations is required.

When analyst

data became

widely available

in machine-readable

form. academics began to use analysts earnings forecasts

in lieu of time-series

model forecasts to proxy for

the markets unobservable

earnings expectation.

The remainder

of this article proceeds as follows. Section 2 discusses a branch of the earnings

forecasting

literature

which continued

to evolve

without direct links to capital markets research.

It examines

the time-series

properties

of annual

and quarterly

earnings;

what happens to predictive

accuracy

when

additional

information,

beyond

earnings.

is allowed for in the information

set; the analysts

earnings

expectation

process; how analysts earnings forecasts can be

improved;

biases in analysts earnings forecasts;

determinants

of analyst following.

Section 3 examines

the relation

between

accuracy and association;

past quarterly

earnings

numbers

and

post-earnings

announcement

drift: analyst

bchavior

and post-earnings

announcement

drift;

forecast

convergence

an d

post-earnings

announcement

drift; the relation

of analysts

forecasts to abnormal

returns.

The earnings response coefficient literature,

discussed in Section

4, examines

proxies for earnings surprise; determinants

coefficients

of

earnings

response

(ERCs); the functional

form of the ERC cstimation equation;

stock-price

and earnings cxpectations.

Sections 2. 3 and 4 summarize

and critique the

and offer some guidance

for future

literature,

research.

Section 5 focuses on some directions

for future research.

Included therein is the role

of analysts earnings forecasts as inputs for stockprice recommendations:

the role of analyst expcctational

data in post-earnings

announcement

drift studies;

the role of cxpectational

data if

forecast accuracy and association

are (or are not)

two sides of the same coin.

Section 6 provides implications

for other branches of forecasting

research. Special attention

is

paid to two notions: ( 1) the forecasting

literature

has recently

developed

a number

of themes

which have been addressed

by the literature

surveyed

in this paper; (2) the intellectual

focus

of forecasting

research can be sharpened,

and its

impact enhanced.

if it broadens

its perspective

beyond

examining

forecasts

as ends in themselves.

2. A continuation

of the earnings

forecasting

literature

-7. 1. Tirnr-series

One

branch

properties

oJ earnings

of earnings

forecasting

research

L. D. Brown

I Earnings

properties of earnings

numbers

and lacked direct links to capital markets research.

Nevertheless,

the models

developed

by this literature

have been used as

measures of earnings expectations

in capital markets studies. Foster (1977), Griffin (1977), Watts

(1975) and Brown and Rozeff (197Ya) advocated

different Box-Jenkins

(1976) ARIMA models of

the quarterly

earnings

time-series

process. The

Box-Jenkins

model uses (pdq) X (PDQ)

notation,

the Foster

model

is the (100) x (010)

model,

plus a constant.

It is a first-order

autoregressive

model, determined

after seasonally

differencing

the time-series

of quarterly earnings

numbers.

The

Griffin-Watts

model

is the

(011) x (011) ARIMA

model. Both its ordinary

and seasonal

components

are moving average

processes

after

taking

first differences.

The

Brown-Rozeff

model,

expressed

as (100) X

(011) in ARIMA notation,

employs the ordinary

component

of the Foster model (the first term in

parentheses),

and the seasonal component

of the

Griffin model (the second term in parentheses).

Box and Jenkins

(1976) represent

the seasonal

time-series

process via the multiplicative

model:

f&(B)@@.+,

= B(B)O(B)cr,

+ e,,

where w, is a stationary

time-series;

B is the

backshift operator

such that Bh~lI = w,_~, 4(B)

and B(B) are polynomials

in B, namely 4(B) =

1 - &B- . . . -&B

and

0(B) = 1 - 0,B. -oqyBq, @(B)

and O(B),

the seasonal

parts of the model, have the form @(B) = 1 @,5Bs- . . -@,,,sBP

and

O(B) = 1 - O,sBs. . . - 0 ys .B, a, is an independent

and identitally distributed

white noise residual term with

mean zero and variance a,, l, and 0,, is a constant.

The model is of order (p,d,q)

x (P,D,Q).

Autoregressive

parameters

are denoted by p and P;

moving average parameters

by q and Q; d and D

are the degrees of ordinary

and seasonal

differencing

required to achieve stationarity.

Griffin (1977) and Watts (1975) proposed the

model:

(l-B)(l-B)X,=(l-O,B)(l-O,B)a,

per share.

the model:

207

research

(1 - $,B)(l

- B)X,

= (1 - &B4)q

(2)

Brown-Rozeff

(1979a) model, with 0, equal to

zero.

In contrast with the Griffin-Watts

and BrownRozeff models, which require the use of ARIMA

software to estimate model parameters,

the Foster models parameters

are estimable

using ordinary least squares (OLS). It can be estimated

as: X, - X,_, = L+ 4,(X,_, - X,_,) + Y, where

X, is quarterly

earnings

in period t, c is an

intercept

(constant term), 4, is a slope and cy, is

an error term. The ease with which these estimates can be made resulted in its being the most

often used of the three ARIMA

models.

These three ARIMA

models formed the core

of the quarterly

earnings

time-series

model literature.

Many studies

have examined

which

model

generates

the most accurate

quarterly

earnings forecast. Benston and Watts (1978) provided evidence

in favor of the Foster model,

Lorek (1979) argued on behalf of the GriffinWatts model, Collins and Hopwood

(1980) and

Bathke and Lorck (1984) provided evidence in

favor of the Brown-Rozeff

model. For over a

decade, no other quarterly ARIMA

model to be

introduced

was found to be more accurate, on

average. than these three models.

Lee and Chen (1990) showed that these three

ARIMA

models can be improved by incorporating temporary,

short-run

and long-run structural

changes. They argued that structural changes are

commonplace

and that statistical

models incorporating

them provide more accurate

earnings

forecasts

than can be generated

via the three

ARIMA

models.

However,

they did not find

that their procedure

was able to generate

more

accurate forecasts than those by Value Line analysts and they provided

no evidence

along the

association

dimension.

Thus, one cannot infer

that the Lee and Chen procedure generates better earnings

forecasts than can be provided by

analysts.

Although

it was commonly

believed in the late

1970s that annual earnings follow a random walk

Collins

(1)

where X, denotes quarterly

earnings

Brown and Rozeff (1979a) suggested

forrmsiing

of higher

forecast errors in the fourth interim period for time-series

models and financial analysts forecasts,

suggesting

that a

different

forecasting

model may bc needed for the fourth

quarter than is used for the first three quarters.

(or random

walk with drift) model, some researchers

argued that annual earnings

with extreme year to year changes were better described

by a mean-reverting

model [Brooks and Buckmaster

(1976).

Salamon

and Smith (1977).

Beaver and Morse (1978)]. The mean-reverting

model, known as the ARIMA

(0.1 ,l) or integrated moving average (IMA) (1,l) model, has

been used in numerous

subsequent

studies by

accounting

researchers

[Beaver

et al. (lY80.

1987), Collins and Kothari (1989)].

Kendall and Zarowin

(1990), and Ramakrishnan and Thomas (1992) have shown that annual

earnings

are well-described

by a first-order

autoregressive

process in earnings

levels. In contrast with Brooks and Buckmaster

(1976). who

reject the random walk hypothesis

only for extreme earnings

changes,

these studies suggest

that the rejection

of the random walk model is

not confined

to cases of extreme

earnings

changes.

Ramakrishnan

and Thomas

(1992)

show that this behavior

has become more pronounced over time; the mean autocorrelations

at

the first lag in the excess earnings

time-series

(i.e. X, - X,_, - (R - 1)(X,_, - d,_ ,). where X

and d are net income and dividends,

respectively, and R. the required

return on equity, = 1.1)

are - 0.03

and - 0.16

for

the

two

20-year

periods,

19Sl-1970

and 1969-1988, respectively.

Nevertheless,

neither study provided

predictive

evidence

in a holdout

sample,3 and there are

Consider

X,( I - B) = tu,(l -

H,B) .

or

in year 1. a, is the shock

(random

error) in period ts earnings and N, is the moving

average coefficient.

v(a,,a,)

= 0, for all

f # s.

If 0, = 0. the stochastic

process is a random walk. Alternatively.

if H, = 1. the stochastic

process is strictly meanreverting.

Penman (lYY2a) shows that the extent of mean

reversion

can hc inferred by using price to earnings ratios

and price to book value ratios.

Each study estimated the autoregressive

parameters

in two

2%year periods,

hut neither examined

whether

the firmspecific parameter

estimate in the first period yielded more

accurate

forecasts than the random walk predictions

in the

second period.

numerous

ways to generate

a more accurate

annual earnings

forecast than the random walk

IMA (1 ,l) or (autoregressive)

AR (1) models,

by expanding

the information

set beyond

the

time-series

of past annual

earnings

numbers.

This literature

is discussed below.

2.2. Expunding

the information

set upon which

unnuul earnings expectations

are conditioned

Hopwood

et al. ( 1982) showed that the three

ARIMA

quarterly

earnings

time-series

models

can be used to improve the predictive

accuracy

of the annual earnings number.

More specitically, prior to observing the first interim (quarterly)

earnings

report of the fiscal year, one can use

these ARIMA

models to forecast the individual

quarterly

earnings

numbers

which, when summcd, equal an annual earnings forecast which is

1521%

more accurate

than is obtainable

by

extrapolating

from the firms past annual earnings numbers

alone. Hopwood

et al. define the

relative predictive

accuracy of the annual versus

quarterly

models as:

$, (F,,

- Actual, ),/$,

(Fo, - Actual,)

for year j, and Fo, is the forecast from the sum of

quarterly

forecasts for year j ( j = 1 - 5), based

on one of the three ARIMA

models.

Beaver

et al. (1980,

1987), Collins

et al.

(1987) and Freeman

(1987) show that the random walk model can be beaten by expanding

the information

set to include the firms stock

price.

Shroff (1992) shows that a composite

model forecast, utilizing random walk and pricebased model forecasts.

is more accurate than a

random walk model forecast when earnings variability is large relative to stock-price

variability.

These studies suggest that the firms stock price

is based partly on expectations

of future earnings. rather than simply on known, current and

past.

Consistent

with this finding,

earnings.

Brown et al. (1985) show that the firms stock

price is based on analysts expectations

of future

earnings

and that analysts

long-term

earnings

expectations

are more valuation-relevant

than

their short-term

earnings expectations.

Freeman et al. (1982) showed that the random

set beyond the firms past

annual

earnings

to include its past stock-price

and book rate of return. Based partly on these

findings, Ou and Penman (1989a,b),

Ou (1990),

Lev and Thiagarajan

(1991), Lev and Sougiannis

(1992) and Penman

(1992b) showed that nonearnings,

financial statement

data can be used to

predict future earnings.

Some of these studies

also showed that abnormal

returns can be obtained by using publicly available financial statement information,

giving rise to a financial statement information

anomaly.

Ball (1992) suggests

that the financial statement

information

anomaly

is due to accounting

ratios proxying for stocks

expected returns.

As evidence for this view, he

cites Stober (1992), who showed that the Ou and

Penman (1989a,b) algorithm can be used to generate abnormal

returns that continue

at an almost constant

rate for 6 years beyond the earnings prediction

date. Ball argues that if the abnormal returns persist for 6 years, they are likely

to be related

to risk factors,

not to financial

statement

data. Greig (1992) and Holthausen

and Larcker

(1992) also challenge

the Ou and

Penman results.

In summary.

time-series

models confined

to

past earnings generally can be beaten by expanding the conditioning

information

set to include

past quarterly

earnings,

stock prices, book rates

of return,

or other financial

statement

data.

Thus, while the random

walk with drift, IMA

(1,l) and AR(l)

models are reasonable

characterizations

of the annual

earnings

time-series

process, they can readily be improved

on once

additional

information

beyond past annual earnings is allowed

for in the conditioning

information set. More work is needed to determine

whether

a financial

statement

information

anomaly exists and if it does, whether it is more

pronounced

for certain firms and time periods

than for others.

2.3.

Research

has provided

insights into the process by which analysts formulate

their earnings

expectations.

Some studies have examined

why

analysts earnings

forecasts

are relatively

more

accurate than those made by time-series

models.

Brown and Zmijewski

(1987) show that the anal-

advantage

is enhanced

at a time of strikes. Their finding is consistent

with the hypothesis

that analysts are relatively

better than time-series

models at distinguishing

among

permanent,

transitory

and price-irrele[Ramakrishnan

and

vant

earnings

shocks

Thomas (1991)]. H owever, they stack the decks

in favor of analysts by using as benchmarks

those

models

which

do not incorporate

structural

changes

into the quarterly

earnings

generating

process. While the Brown and Zmijewski

results

are intuitively

appealing,

their study should be

replicated

with a stronger

time-series

model

benchmark

and a more sophisticated

methodology before one can reliably conclude that analysts

are better than time-series

models at distinguishing between earnings shocks with different valuation implications.

Fried and Givoly (1982) and Brown et al.

(1987a) investigate

whether an analysts forecasting advantage

relative to that of a time-series

model is attributable

to two information

factors:

(1) analysts

have a contemporaneous

information

advantage

they utilize information

available

on the earnings

announcement

date

other than the sequence

of known quarterly

earnings

numbers;

(2) analysts

have a timing

advantage

they utilize information

acquired

after the time-series

model forecast

initiation

date (i.e. the earnings announcement

date), such

as management

forecasts,

macroeconomic

data

and industry variables.

Fried and Givoly (1982)

use annual earnings data from the, now defunct,

Standard

and Poors Earnings Forecaster, and

find that only the first (contemporaneous)

information

factor

is significant.

Brown

et al.

(1987a) use Value Line quarterly

forecasts,

and

find both the timing and contemporaneous

information

factors to be significant.

Nevertheless,

neither study provides insights into the relative

importance

of alternative

information

sources for

explaining

the analysts

forecasting

advantage.

Brown et al. (1987~) use both Institutional

Brokers Estimation

System (I/B/E/S)

consensus

(mean) forecasts and Value Line forecasts,

and

argue that the analysts

forecasting

advantage

relative to time-series

models is attributable

to

three characteristics

of the information

set conditioning

analysts expectations:

(1) the amount

of information

available;

(2) the precision of this

information;

(3) the correlation

among the in-

formation

variables.

Using firm size, the homogeneity of analysts earnings expectations

and the

number

of lines of business

(LOB),

as proxies

for the

amount,

precision,

and correlation

among the information

variables,

respectively,

Brown

et al. (1987~) show that the analysts

relative advantage

in forecasting

annual earnings

is positively

related to firm size and the homogeneity of analysts expectations.

Finding no relation

between

the analysts

relative

earnings

forecasting

advantage

and the number of LOB,

they suggest that the number

of LOB is too

crude a proxy for the correlation

among the

information

variables to allow for definitive findings. Their reasoning is as follows: Suppose that

(analysts

possess) tz information

signals (which)

relate to m lines of business. If m is small, the n

information

will

be

highly

corsignals

related.

. if wz is large and each of the n information

signals is randomly

assigned to one of

the m lines of business, the II information

signals

will tend to represent

more diverse types of

information.

This argument

is not very persuasive, as there is no reason to believe that each of

the y1 information

signals is randomly assigned to

one of the m lines of business.

Employing

Value Line quarterly

forecasts,

Kross et al. (1990) also use the number of LOB

to proxy for the correlation

variable and find it

to lack explanatory

power. One explanation

for

the poor LOB results is that the variable

is

significantly

correlated

with firm size and the

homogeneity

of analysts expectations

[Brown et

al. (1987c), p. 601. Another

explanation

for the

poor LOB results is that the correlation

among

the information

variables

is not an important

determinant

of analyst

forecast

superiority.

Nevertheless,

Branson

and Pagach (1993) show

that the Value Line analysts predictive

advantage vis-a-vis the Brown-Rozeff

(1Y79a) model.

is significantly

positively related to LOB for twoand three- (but not one) quarters-ahead

forecast

horizons.

Additional

research is needed to determine whether the Brown et al. (1987~) theory

is poorly specified, the number of LOB is a poor

proxy for the correlation

variable,

or both.

Kross et al. (1990) show that the analysts

advantage

in forecasting

annual

earnings

increases with the firms earnings

variability

and

the amount of coverage by the Wull Street Journal. This provides

additional

evidence that anal-

advantage

vis-a-vis

time-series

Kim

models.

Similarly,

and

Schroeder

(1990) suggest that analysts utilize a

wide variety of non-earnings

information

sources

when forecasting

annual

earnings.

They show

that analysts anticipate

discretionary

accruals in

earnings

reports

of firms with earnings-based

bonus plans.

Collins et al. (1987) and Freeman

(1987) extend the work of Beaver et al. (1980, 1987) and

Beaver ct al. (1987) by examining

the relation

between

firm size and the predictive

advantage

of price-based

forecasts versus predictions

of a

naive earnings expectation

model. Arguing that

stock price is a more efficient

aggregator

of

information

for larger firms, Collins et al. and

Freeman

show that price-based

forecasts

for

larger firms have a predictive advantage

vis-a-vis

smaller

firms. Larger firms have richer information environments

than smaller firms, owing

to the information

acquisition

and dissemination

activities

of analysts and institutional

investors

[Atiase

( 198.5),

Bambcr

(1987),

Bhushan

(1989)]. Thus, it is relatively

more difficult for

larger firms managers

to withhold their private

information

[Brown and Kim (1993)], and larger

firms stock prices incorporate

information

relatively more rapidly.

Collins et al. (1987) and Freeman (1987) interpret their findings

as being consistent

with a

firm-size

differential

information

environment

hypothesis.

However, the random walk model is

a weak benchmark

for forecasting

annual earnings (e.g. it can be improved on simply by using

the firms past quarterly earnings numbers in lieu

of its past annual earnings numbers [Hopwood et

al. (1982)]). so these results should not be considered as definitive evidence of a firm-size based

explanation.

Before the evidence can be considered definitive,

it is necessary

to demonstrate

that the firm-size results are robust to stronger

time-series

benchmarks,

such as ones incorporating past quarterly

earnings numbers.

If the relative predictive advantage of using quarterly earnings in lieu of annual

earnings

is greater

for

smaller firms, the firm-size results may not be

robust to this stronger

time-series

benchmark.

Brown et al.s (1985) finding that stock price is

a leading indicator of analysts earnings forecast

revisions

suggests that the analysts information

advantage

may be attributable

to the incorpora-

L.

D. Brown

I Earnings forecmting

forecasts.

If so, the analysts comparative

advantage over univariate

time-series models may arise

from their utilization

of public rather than private information.

However, a price-based

explanation for the analysts comparative

advantage is

unlikely.

Stickel (1990) shows that the change in

the consensus

(mean) estimate and the analysts

deviation

from the consensus estimate are much

more important

determinants

of analysts earnings forecast revisions than is the firms lagged

stock price.

Thus,

the analysts

comparative

earnings forecasting

advantage

appears to result

at least partly

from the utilization

of firmspecific, private information,

not public information

reflected

in stock price. The evidence

that analysts possess private information

facilitating their earnings

predictions

is consistent

with

the finding that analysts possess private information enabling them to generate superior forecasts of firms future stock prices [Copeland and

Mayers (1982), Coggin and Hunter (1983). Dimson and Marsh

(1984),

Elton et al. (lY%),

Brown et al. (1991)]. However,

little is known

regarding

how much of the analysts predictive

advantage

is due to the utilization

of private

rather than public information.

In summary,

the analysts earnings forecasting

advantage

relative to time-series

models is partly

attributable

to their private information

acquisition activities,

which may enable them to better

distinguish

between

permanent,

transitory

and

price-irrelevant

earnings shocks. Their comparative advantage

is greater when the forecast is for

a larger firm, with more information

acquisition

activities,

greater earnings

variability

and more

homogenous

analyst

expectations.

Additional

work is needed to ascertain whether the correlation among

information

variables

is a viable

factor explaining

the analysts comparative

advantage.

Moreover,

the validity of the firm-size

explanation

and the role of public versus private

information

acquisition

in explaining

the analysts predictive

advantage

await future study.

2.4. Improving

whether analysts earnings forecasts can be pooled with those

of time-series

models to generate relatively more

accurate earnings forecasts than can be made by

reseurch

301

models individually. Newbold

et al. (1987) show that pooling

Value Line earnings forecasts with forecasts generated via the Brown and Rozeff (1979a) quarterly earnings time-series

model results in more

accurate

earnings

forecasts

than produced

by

either the Value Line analyst or the BrownRozeff model individually.

Conroy and Harris

(1987), Guerard

(1989), Lee and Chen (1990)

and Lobo ( 1991) use different

univariate

timeseries model forecasts, and show that predictive

ability can be enhanced

by pooling time-series

model forecasts with analysts forecasts. Elgers

and Murray (1992) show that I/B/E/S

consensus

forecasts,

when pooled with stock-price

based

forecasts

using the procedure

of Beaver et al.

(1980, 1987), generate

more accurate forecasts

than are available using either model individually. Stober (1992) shows that the summary financial statement

measure (Pr) derived by Ou and

Penman (1989a,b) works best when Pr indicates

buy and I/B /E/S consensus

analyst revisions

suggest sell.

Several studies interpret their own evidence as

suggesting

that analysts do not use all the information

in financial

statements

and stock

prices when formulating

their annual

earnings

expectations.

However,

one cannot

conclude

that this is the case since these studies use consensus, rather than individual,

analyst earnings

expectations.

As discussed below, some of the

forecasts included in the consensus

forecast are

not conditional

upon the financial statement

information

that these studies maintain

is ignored

by the analysts.

The contention

that analysts

disregard information

in financial statements

(or

stock prices) is warranted

only if the consensus

analyst forecast

is based on individual

analyst

forecasts made after the date that the financial

statement

(or stock-price)

data are available

[Brown and Han (1992)].

Lys and Sohn (1YYO) and Abarbanell

(1991)

use detail analyst forecasts rather than consensus

Conroy and Harris (1987) used I/B/E/S

consensus

forccasts, Guerard

( 1989) uses consensus forecasts of the Standard and Poors Earnings Forecaster. Lee and Chcn (1990)

use Value Line forecasts.

and Lobo (1991) uses Value Line

and I/B/E/S

consensus forecasts.

See Philbrick and Ricks

(1991) for a discussion of the advantages

and disadvantages

of these three sources of earnings

forecasts,

as well as

Zacks Investment

Research forecasts.

forecasts do ignore information

reflected in stock

prices prior to the forecast-release

date. They

conclude that analysts earnings forecasts do not

incorporate

all the information

in prior stockprice changes,

suggesting

that analysts

are inefficient in collectingandior

interpreting

publicly

available

information.

A finding that analysts ignore publicly available information

is unsatisfactory

to capital markets researchers

who advocate semi-strong

form

market efficiency [Fama (1970)], but it is satisfactory to behavioral

researchers

who maintain

that people consistently

overweight

some cues

and underweight

others [Tvcrsky and Kahneman

(1984). Gilovich

et al. (l%S),

Mear and Firth

(1987),

Hunter

and Coggin

(1988).

DeBondt

(1993)]. Abarbanell

(1991) suggests that analysts

have incentives

to provide

new forecasts

only

when they obtain information

which is independent of prior stock-price

changes. Hc maintains

that this strategy makes it easier for investors to

infer the analysts private information:

. . private information

is more easily inferred by invcstors if it is not combined

with other signals

whose information

content is open to individual

interpretation

(p. 164). This view is controvcrsial as other studies have taken an opposite view.

For example, Kane et al. (1984) suggest that it is

easier to infer the valuation

implications

of dividend (earnings)

information

which is combined

with and corroborated

by earnings

(dividend)

information.

While the descriptive

validity

of

Abarbanells

scenario

versus the behavioralist

interpretation

awaits additional

research,

analysts do appear to ignore publicly available data

already incorporated

in past earnings and stock

prices.

Some studies have examined

ways to improve

analysts earnings forecasts without pooling them

with other information.

OBrien

(1988) shows

that the most recent I/B /E/S analysts earnings

forecast

is more accurate

than the consensus

(mean) forecast.

Although

this appears to contradict

the forecast

aggregation

principle

that

aggregation

improves predictive

accuracy by re

search.

which

same

represent

date.

It~~~e.rrmet~/

Zacks

Investment

date.

week

lb-

approximately

Sur,ry

(1091)

ducing idiosyncratic

error. studies finding evidence consistent

with the aggregation

principle

[Ashton

and Ashton

(19X5), Libby and Blashheld (1978).

Winkler

and Makridakis

(1983)]

examined

equally recent forecasts.

Analysts

earnings

forecasts

are not usually

equally

recent.

They

make

their

forecasts

throughout

the year, rather than at any set time,

such as on earnings

announcement

dates. As

some forecasts included in the consensus may be

more than 6 months old [OBrien (19X8)]. the

analyst ignores two quarterly

earnings

reports.

Since analysts

earnings

forecasts

can bc improved simply by substituting

in known quarterly

earnings

numbers

for their previous

expected

values, leaving intact forecasts for the remainder

of the year [Brown

and Rozeff

(1979c)].

it

should

be possible

to improve

analysts

consensus forecasts by deleting old estimates.

Brown

(1991) shows that earnings

forecast

accuracy

can be improved

by discarding

old

earnings

forecasts.

Using detail Zacks Investment Research

data, Brown finds that each of

three *timely composites

(i.e. the most recent

forecast,

an average of the three most recent

forecasts and the 30-day average) is more accurate than the mean forecast. Moreover,

the comparative advantage

of each timely composite depends on firm size; the most recent forecast is

approximately

as accurate as the 30-day average

for small firms, but the 30-day average is significantly

more accurate

than the most recent

forecast

for large firms. These results can be

interpreted

as follows. The aggregation

principle

pertains

to the 30-day average

of large firms

because these firms are followed by many analysts. In contrast, small firms are followed by few

analysts

and even fewer analysts

make their

earnings forecasts within 30 days of each other.

Browns

results

suggest

that the aggregation

principle pertains to earnings forecasts which arc

equally timely, but not to those made at different

points of time.

Several studies have examined

if there exists a

superior

analyst. Using a small sample of Value

Line

earnings

forecasts,

Brown

and Rozeff

(1980) conclude

that superior forecast ability is

before

made on the

the

Vuluc

Lirw

directly

following

the

firm.

positively

correlated

examine

However.

the number

of analysts

analyst hollowing

is highly

not evident.

Using a much larger sample of

I/B /E/S data and a more powerful methodology, OBrien (1990) reaches the same conclusion.

However,

Stickel (1992) uses a large sample of

Zacks Investment

Research

data and concludes

that members

of the Institutional Investor All

American

Research Team are superior earnings

forecasters.

Unlike

OBrien

(1990), he uses a

matched

pair design which fully controls

for

forecast

recency.

Using I/B/E/S

data and a

more powerful control for forecast recency than

OBrien (1990) and Sinha et al. (1993) conclude

that superior analysts do exist.

Using detail Zacks Investment

Research data,

Stickel (1990) shows that analysts annual earnings forecasts can be improved by updating them

with publicly

available

data.

Indeed,

Stickel

(1993) demonstrates

that these updated forecasts

are more accurate than those of the three timely

composites

examined

by Brown (1991). Thus,

the aggregation

principle

pertains

to earnings

which are made at different points in time, provided that they are updated with publicly available data.

In summary,

there are numerous

ways to improve analysts

earnings

forecasts,

such as by

pooling them with time-series

model forecasts,

stock prices, or financial statement

data. Consensus estimates

can be improved

by discarding

old forecasts and by including updated forecasts

in the consensus.

Analysts

do not appear

to

process publicly available information

efficiently

and there appears to be some difference in their

abilities

to forecast earnings.

Why analysts do

not process information

efficiently

and what is

the nature of the information

they underweight/

overweight

are interesting

topics

for future

research.

2.5.

Biases in analysts

earnings

forecasts

biases in analysts earnings forecasts. Fried and Givoly (1982)

and OBrien (1988) show that analysts earnings

forecasts generally

are overly optimistic.

Butler

and Lang (1991) find the analysts

degree of

optimism

or pessimism to persist over time and

that the degree of persistence

is independent

of

the level of the firms earnings predictability

(as

defined by Value Lines earnings

predictability

ranking).

Biddle and Ricks (1988) show that

analysts

were overly optimistic

regarding

the

earnings

of firms that adopted

last-in-first-out

(LIFO) in 1974. All of these studies suggest that

analysts

may intentionally

generate

optimistic

forecasts.

However,

Affleck-Graves

et al.

(1990) show that disinterested

judges exhibit

significant

optimistic

biases. This suggests that

analysts biases may be attributable

to judgmental heuristics

employed

in earnings

per share

predictions,

and thus are, partly, unintentional.

Sell-side analysts are more optimistic when the

firms they work for either underwrite

the securities of the companies

whose earnings

they

estimate

[Lin and McNichols

(1991)] or act as

the companies

investment

bankers

[Dugar and

Nathan (1992)]. Sell-side analysts are employed

by brokerage

Firms and their forecasts are reported

externally.

Buy-side

analysts

are employed by banks. insurance

companies

and pension funds, and their forecasts are used internally

by the firms portfolio managers.

Sell-side analysts are relatively

more likely to possess an

optimistic bias because they are paid, in part, by

the amount of commissions

they generate [Dorfman (1991)]. It is much easier to get clients to

buy stocks than to sell them (especially to convince clients to short-sell

stocks they do not

own). Moreover,

if the firms that employ them

underwrite

securities or act as the firms investment bankers,

sell-side analysts have additional

incentives

to provide optimistic

forecasts so as

not to upset their firms clients [Siconolh (1992)].

Dugar and Nathan (1992) show that the stock

market

is aware of and adjusts for this bias.

However,

they do not determine

whether

the

adjustment

is complete,

so it is unclear whether

capital markets fully extract the bias.

Francis and Philbrick (1992) show that Value

Line analysts are overly optimistic, in spite of the

fact that Value Line Inc. neither

underwrites

securities

nor provides investment

banking

ser-

Alternative

interpretations

of the evidence

are that the

testing methodologies

lack sufficient

power or improper

assumptions

are made regarding

market

efficiency

(e.g.

zero information

acquistion.

dissemination

and processing

costs).

Fried

and

Forecaster

l/B/E/S

and Poors

and Poors Eurnin~.s

data; OBrien and Butler and Lang use detail

data; Biddle and Ricks use data from Standard

Earnings

Forecaster.

managers

to bc overly optimistic

in order to

remain

privy to managers

asymmetric

information,

but an alternative

explanation

for their

result is the Aflleck-Graves

et al. (1990) finding

that

the optimistic

bias is unintentional.

A

stronger

test of analyst optimism

would be to

examine

the biases, if any, of buy-side analysts,

as it is not evident

that these analysts

have

incentives

to be overly optimistic.

Using l/B/E/S

consensus

data. DeBondt

and

Thaler (1990) conclude

that analysts over-react

to extreme

earnings

changes

and returns.

Although

this is not mentioned

by the authors,

analysts

are more likely to over-react

if they

believe

that annual

earnings

follow a random

walk with drift process (e.g. analysts ignore the

evidence

that annual

earnings

revert to their

mean values, especially when year to year carnings changes are extreme).

Klein (1990) argues

that analysts over-reaction

to extreme earnings

changes

and returns

requires

them to undcrpredict

annual

earnings

after large stock price

declines

and over-predict

earnings

after large

stock-price

increases.

Her findings. however, are

the opposite (i.e. analysts earnings estimates are

overly optimistic

after stock-price

declines).

She

interprets

her evidence as suggesting that managers whose firms face adverse conditions

pressure analysts to make overly optimistic forecasts.

However.

in the light of my conversations

with

Value Line personnel,

I would suggest that analysts tend to be overly optimistic

when a firm

expcrienccs

adverse times without

being pressured by managers.

Analysts do not often predict

that firms will fail; they are more likely to expect

a reversion

to the mean

(i.e.

better

times

ahead). Behaviorists

would characterize

such behavior as underweighting

(overweighting)

recent

(past) cues.

In summary,

the evidence suggests that analysts do possess a positive bias; their degree of

optimism

or pessimism

persists through

time;

and their optimistic

bias is greater when firms

employing

them are underwriters

or investment

bankers

of the companies

whose earnings

they

estimate.

Further research is needed to ascertain

how much of the bias is unintentional;

the causes

of intentional

analyst bias; whether capital markets fully extract these, intentional

and unintentional, biases.

2.6.

Modeling

analyst

following

analysts following a firm is positively

related to

the number of institutions

holding its shares, the

percentage

of its shares held by institutions,

the

variance of its daily returns, the R-squared

from

the market model regression of its returns on the

market return, and the market value of its equity. His arguments

regarding an expected positive

relation between analyst following and both the

variance

of the firms daily stock-price

returns

and the R-squared

from the market model regression

(i.e. the regression

of the firms daily

stock-price

returns

on the return

of a valueweighted

market portfolio)

are as follows. Private information

is useful and it is more useful

for firms with higher return variability.

The cxpetted trading profit is an increasing function of

the probability

of obtaining

a large deviation

between

the expected

return conditional

on all

known information

and the expected return conditional

on public information.

The expected

trading

profit based on private information

is

higher for firms with higher return variability and

the aggregate

demand for analyst services is an

increasing

function

of the firms return

variability.

Bhushan

argues that a firms marginal

information

acquisition

cost is lower if it has a

higher R-squared

from a market model regression. and that an increase in the R-squared

betwcen firm and market returns

is likely to increase

total expenditures

on analyst

services.

However,

his use of cross-sectional

data to test a

temporal

model makes it difficult to interpret his

results.

Brennan

and Hughes

(1991) show that the

number of analysts following a firm is positively

related to firm size and the variance of return.

and negatively

rclatcd to share price. They contend that managers

with favorable

mm-specific

private information

split their shares in order to

reveal their favorable

private information

to investors: lower priced shares cause increased following by investment

analysts and increased following by analysts

increases

the timeliness

of

firm-specific

information

disclosures.

Brennan

and Hughess hypothesis has not yet been tested.

One way to test it would be to examine whether

firms, after splitting their shares, provide invcstors with more timely information,

such as mak-

relatively closer to the fiscal quarter-end

to which

the earnings

pertain.

OBrien

and Bhushan

(1990) investigate

the

joint

analyst-institution

decision

process,

and

show that the relation between analyst following

and tirm size is eliminated

once analysts decisions to follow firms and institutional

investors

decisions

to hold these firms in their portfolios

are jointly determined.

They find that changes in

analyst

following

are positively

related to net

entry of firms into the industry and regulation,

and negatively

associated

with the amount

of

pre-existing

analyst following and changes in volatility. Volatility is defined as the residual standard error from a market-model

regression.

The

authors maintain

that analysts prefer regulated

industries

because regulatory

oversight and disclosures provide operating

information

that supplements

financial disclosures,

reducing analysts

information

acquisition

costs. While not mentioned by the authors.

increased

disclosures

by

regulated

firms are likely to reduce

the incremental

value of analysts information

gathering activities.

making it less attractive

for them

to follow these firms. OBrien

and Bhushans

results suggest that analyst following should be

modellcd

jointly

with institutions

decisions

to

avoid drawing

erroneous

inferences

regarding

the determinants

of analyst following.

The lack of robustness

of the Bhushan (1989),

Brennan

and Hughes (1991), and OBrien and

Bhushan (1990) findings to the manner in which

the decision

process is specified suggests that

analyst following

may be related to firm size if

factors additional

to the analyst-institution

decision process are considered.

The lack of robustness to model specification

implies that the theoretical

relation

between

analyst following

and

firm size needs further elaboration.

forecasting research on capital markets

research

3.1. Accuracy

versus association

surprise with abnormal returns

of forecast

as to whether

the

model that is best in the accuracy dimension

is

forecusring

research

305

dimension

(i.e. has the

strongest

association

with abnormal

returns).

Fried and Givoly (1982) focus on annual earnings, and show that forecasts generated

by the

Standard

and Poors Earnings Forecaster outperform

two univariate

time-series

models

in

both dimensions.

Bathke and Lorek (1984) examine the quarterly

earnings

forecasts

of five

univariate

time-series

models, and conclude that

the Brown and Rozeff (1979a) ARIMA model is

best in both dimensions.

Brown et al. (1987a,b)

show that quarterly

earnings forecasts by Value

Line analysts are better than those of five univariate time-series

models in both dimensions.

Brown (1991) and Brown and Kim (1991) use

Zacks Investment

Research

data to show that

three timely composites

are better than the consensus (mean) quarterly earnings forecast in both

dimensions.

Thus, several studies have obtained

similar results using both the accuracy and association

metrics.

Other studies find the opposite,

namely that

more accurate earnings forecasts do not generate

earnings

surprises which are more highly correlated with contemporaneous

abnormal

returns.

In a seminal study, Foster (1977) examined

six

univariate

time-series

models of quarterly

earnings and found the (100) X (010) model plus a

constant

to be best in the predictive

ability dimension,

but the seasonal

random

walk with

drift model (i.e. the (000) x (010) plus constant

model)

to be best in the market

association

dimension.

Hughes

and

Ricks

(1987)

and

OBrien

(19&S), respectively,

use Standard

and

Poors Earnings

Forecaster and IiBlElS

consensus data. and find analysts annual earnings

forecasts

to be better than time-series

model

forecasts in the predictive ability dimension.

but

not in the association

dimension.

Philbrick

and Ricks

(1991)

examine

four

sources of analyst data: Value Line, I/B/E/S,

Standard

and Poors Earnings Forecaster,

and

Zacks Investment

Research.

They find that the

smallest absolute forecast errors are obtained by

pairing

Value Line forecasts

with Value Line

actuals and that the strongest associations.

using

a 3-day window, are obtained

using Value Line

actuals with Value Line or I/B/E/S

forecasts.

Their results suggest that the source of actual

earnings per share (EPS) data is more important

than the source of forecasted

EPS data. This

using the same sources of forecasts and actuals

[e.g. Brown et al. (1987a,b)]

with those using

different

sources of forecasts

and actuals [e.g.

Hughes and Ricks (19X7)]. The former, but not

the latter, studies have found predictive

ability

and association

to be two sides of the same coin.

Stickel (1990) shows that the accuracy of analysts annual earnings forecasts can be improved

by updating

them with publicly available

data.

Indeed, Stickel (1993) shows that these updated

forecasts are more accurate than the three timely

composites

examined

by Brown (1991). Stickcl

( 1991) shows that earnings-forecast

errors conditional

upon these updated

forecasts

are less

highly associated with abnormal

returns than arc

forecast errors conditioned

on the non-updated

forecasts.

Hopwood

and McKcown

(1990) find

Value Line forecasts.

for quarterly

and annual

earnings.

to be more accurate

than those of

time-series

models and the association

evidence

to be in favor of the Value Line analyst for

annual.

but not quarterly,

earnings.

Wicdman

(1993) obtains the opposite

result, that is, she

finds a higher association

for time-series

model

forecasts than for I/B/E/S

forecasts for annual,

but not quarterly,

earnings.

In summary,

the findings of Fried and Givoly

(1982). Bathke and Lorek (1984). and Brown et

al. (1987a,b)

suggest that accuracy and association arc two sides of the same coin. However.

the evidence of Foster (1977). Hughes and Ricks

(1987).

OBrien

(198X).

Hopwood

and McKeown

(1990).

Stickel (1991),

and Wiedman

(1993) suggests otherwise.

The issue of whether

the model that is best in the accuracy dimension

is best in the association

dimension

is unresolved. If the best model in the association

dimension

is not best in the accuracy dimension.

capital market efficiency in a conventional

sense

appears to be violated, provided that analysts arc

the market, that is they arc the marginal price

setters.

However,

such evidence

is consistent

with behavioral

research showing that individuals

improperly

weight

information.

Alternatively,

the evidence

is consistent

with a less stringent

definition

of market

efficiency

than the one

Wiedman

made more

&dines

casts.

USC\ I/R/E/S

than 2 months

a consensus

detail

prior

data,

discards

forecasts

to the quarter-end

and

forc-

which is generally

employed.

Additional

restarch

is needed to determine

which of these

scenarios

is the most descriptively

valid.

3.2. Past quarterly earnings numbers

eurnings unnouncement

drift

and post-

The concept

of post-earnings

announcement

drift has a long history in accounting

and finance

literature

[Ball and Brown (1968), Joy et al.

(1977), Watts (197X). Foster et al. (1984)]. Ball

and Brown showed that stock-price

movements

after annual earnings announcements

are in the

same direction

as consecutive

annual

earnings

changes.

Thus. if annual earnings

in year t exceed, or fall short of, those of year t - 1. stock

prices move up. or down, after year t earnings

arc announced.

Stock-price

movements

after

year t earnings

are announced

are known as

post-earnings

announcement

drift. Rendleman

et

al. ( 1987) showed that stock prices fail to capture

fully the implications

of current quarterly

earnings for future earnings.

Observing

significantly

positive adjacent yuartcrly autocorrelations.

they

argued that investors fail to recognize the implications of quarter

t earnings

for quarter

t+ 1

earnings.

Bernard

and

Thomas

(1990)

extend

the

Rendlcman

et al. analysis by incorporating

implications of quarter t earnings for quarter t + 1 to

t + 4 earnings.

They show that the 3-day stockprice reaction around the time of quarterly earnings reports

is predictable,

conditional

upon

knowledge

of the past four quarterly

earnings

numbers.

More specifically. they argue that stock

prices erroneously

act as if quarterly

earnings

follow a seasonal random walk with drift model,

in fact, quarterly

earnings

follow the

when.

(011) x (011) Box-Jenkins

ARIMA process [i.e.

the model

suggested

by Brown

and Rozeff

( 1979a)] Thus. stock prices mistakenly

behave

as if the current quarterly

earnings shock has a

positive impact on earnings four quarters hence.

I ~lheconventional

ing.

generating

explanations

definition

and processing

information.

better

curacy and/or

association

both dimensions

included

than tither

in the study.

dimensions

Alternative

than model B on

includc:

defined:

ac-

mod-

model C is better

on

quarters

hence. If stock-price

movements

conformed

with the implications

of the BrownRozeff model,

the stock-price

reaction

to the

quarter t earnings number would incorporate

the

positive impact of the current shock on the next

three quarterly

earnings

numbers,

each with a

lesser influence,

and possibly a negative impact

on earnings

four quarters

hence. The current

shock will exert a negative impact on earnings

four quarters

hence if the moving-average

seasonal component

more than offsets the autoregressive

ordinary

component.

[Recall that the

Brown-Rozeff

model in Box and Jenkins (1976)

notation

is (100) X (01 l)].

Re-examining

the Bernard and Thomas (1990)

result on a holdout sample, Bartov (1992) provides predictive

evidence

which validates

their

findings. He shows that once the implications

of

past quarterly earnings for future quarterly earnings are controlled,

the positive relation between

unexpected

earnings in quarter t and stock-price

drift in quarter

t + 1 disappears.

He concludes

that post-earnings

announcement

drift is fully

explained

by the failure of the market to correctly characterize

the

time-series

process

of

earnings.

The failure of stock prices to fully capture the

time-series

properties

of the quarterly

earnings

generating

process gives rise to the cockroach

theory of earnings

surprises - goodlbad-news

quarterly

earnings

reports precede other good/

bad-news

quarterly

earnings

reports. Similar to

cockroaches,

you never find just one of them!

Bernard

and Thomas

(1990) maintain

that the

expected number of cockroaches

is five - the

current one and the four subsequent

ones, where

the second and third subsequent

earnings shocks

are smaller

in size than their immediate

predecessors,

and the fourth subsequent

earnings

shock is opposite in sign to the current one.

In summary,

there is considerable

evidence

that stock prices fail to capture the implications

of current quarterly earnings for future quarterly

earnings.

The failure of stock prices to fully

capture the time-series

properties of the quarter In a somewhat

and Tse (1989)

found at least a SO% decline in post-earnings

announccment drift following

quarter

ts earnings

announcement

when observations

were matched on quarter t + Is carnings innovations.

ly earnings generating

process appears to violate

semi-strong

market

efficiency

[Fama

(1970)).

Whether

the anomaly

occurs, and, if so, why,

are interesting

topics for future research.

3.3. Analyst behavior and post-eurnings

announcement drift

Mcndenhall

(1991) shows that: (I) analysts

underestimate

the serial correlation

in quarterly

earnings,

(2) investors

use analysts

earnings

forecast revisions to reassess the persistence

of

their previous

forecast errors and (3) investors

systematically

underestimate

the persistence

of

their previous

forecast

errors.

Assuming

that

stock prices capture security analysts earnings

expectations,

Mendenhalls

results are consistent

with those of Bernard and Thomas.

Similar

to Mendenhalls

results

regarding

quarterly earnings, but in contrast with an earlier

study of annual earnings by Givoly (1985), Ali et

al. (1992) find that analysts generally

underestimate the permanence

of the current annual earnings surprise

with regard

to future

annual

earnings. More specifically,

Ali et al. show that

analysts generally are overly optimistic regarding

the subsequent

years annual earnings and that

their annual earnings forecast errors display significantly

positive

serial

correlation.

Givoly

found analysts forecasts to be unbiased and their

prediction

errors

to be serially

uncorrelated.

However,

his sample is much smaller than that

of Ali et al. (i.e. Givolys results were based on

as few as 378 firm-years; Ali et al.s findings were

based on 3184-5305

firm-years).

The latter rcsults appear to be relatively more credible. given

the studys larger sample and more powerful

methodology.

Using Value Line data, Abarbanell

and Ber Stock prices do not fully capture

analysts expectations,

but the degree of proximity

should be close enough to

make the Mendenhall

(IYYI) and Bernard

and Thomas

(1989. 1990) results reasonably

consistent with each other.

As evidence that stock prices do not fully capture analysts

expectations,

see Ahdel-khalik

and Ajinkya

(1982) and

Elton et al. (1981).

who show that analysts

forecast

revisions led stock price changes. Their respective sources

of analyst forecasts are Merrill Lynchs Option Alerr and

I/B/E/S

consensus

data.

Mendenhall

u5es

Value Line data; Givolv uses Standard

and Poors Eurnings Forecaster detail data; Ali et al. use

I/B/E/S

consensus

(median) data.

forecasts under-react

to recent earnings

announcements in a manner

similar to the -?-day stockprice under-reaction

observed

by Bernard

and

Thomas

(1990).

They conclude

that security

analysts behavior

is, at best, only a partial explanation

for stock-price

under-reaction

to earnings and. hence,

post-earnings

announcement

drift. Their conclusion

is consistent

with the

cvidencc

of Brown and Rozeff (197Yb), who

showed that analysts do not act as if the quarterly earnings generating

process is a seasonal random walk with drift. In order for analysts behavior to explain

post-earnings

announccmcnt

drift, analysts would have to act as if the carnings generating

process was a seasonal random

walk with drift. As mentioned

earlier, Bernard

and Thomas

(1YYO) maintain

that stock prices

erroneously

act as if quarterly

earnings follow a

seasonal random walk model with drift (seasonal

submartingale)

model. Both Brown and Rozcff

( lY7Yb) and Abarbanell

and Bernard

( lYY2)

show that, similar to the Foster (1977) model,

analysts

act as if the quarterly

earnings

timeseries process is autoregressive.

Thus, it is not

surprising

that security

analysts behavior

only

partly explains the Bernard and Thomas ( 1990)

results. Additional

work is needed to further our

understanding

of the relation

between

analyst

behavior

and post-earnings

announcement

drift.

the relation between earnings

announcements

and the convergence of analysts expectations

of future carnings.

Bayesian

theory

suggests

that earnings

announcements

generally

increase

the

precision of individuals

estimates of future earnings

numbers.

The dispersion

among

individuals

earnings

expectations

is often used to proxy for

the precision

of individuals

estimates

of future

earnings

[Ajinkya

and Gift (lYX5), Brown ct al.

( lYX7c)]. Morse et al. ( 199 1) examine this issue

with l/B/E/S

consensus

(mean) forecasts

and

conclude

that earnings announcements

decrease

the homogeneity

of analysts cxpcctations

of future earnings.

Their results are inconsistent

with

their intuition,

Bayesian

theory and the timcseries properties

of earnings.

The joint evidence

earnings generating

process is

autoregressive

[ Lipe and Kormendi

( lYY3)], and

that analysts

act as if the quarterly

earnings

generating

process is autoregressive

[Brown and

Rozcff ( lY79b)], implies that earnings announcements should increase the precision of analysts

earnings expectations.

The intuition

is that each

individual

revises his/her

forecast in the direction of his/her error (actual minus forecast).

As

shown by Morse et al. ( lY91), unless the errors

are very large. the homogeneity

of analysts forccasts of future earnings

will increase after observing current earnings.

Brown and Han (IY92) argue that the Morse

ct al. results arc due to their use of consensus

(mean) analyst forecasts. Since analysts earnings

forecasts arc not all made at the same point in

time [OBrien

(19xX)], some of the individual

forecasts

included

in the consensus

obtained

after the earnings

announcement

were dated

prior to the earnings

announcement.

In other

words, not all forecasts included in the Morse et

al. study

were conditioned

on the earnings

announcement

that the analysts supposedly

had

as inputs into their decision models. Brown and

Han ( lYY2) USC detail I/B/E/S

forecasts dated

after the earnings announcement,

and show that

earnings

announcements

generally

increase

the

homogeneity

of analysts expectations

of future

earnings.

Consistent

with Bayesian

theory and

Morse et al.s intuition.

Brown and Han find that

analysts expectations

of future earnings become

more dispersed

only when earnings

surprise is

very large (i.e. for the top decilc of earnings

surprise).

The joint evidence

that timely composites

of

analyst

earnings

estimates

are more accurate

than

the consensus

(mean)

analyst

estimate

[OBrien (IYXX), Brown (1991)]. that errors conditional

upon timely composites

of earnings are

relatively

more highly associated with abnormal

returns [Brown and Kim (19Yl)] and that analysts expectations

of future

earnings

become

more homogenous

upon observing current earnings when using individual.

but not consensus,

analyst forecasts [Brown and Han (lY92)]. suggests that researchers

should use individual analysts forecasts in lieu of consensus analysts forecasts when requiring

a proxy for the markets

earnings

expectation

or the precision

of individuals expectations.

Given that l/B/E/S

and

L, D. Rrown

Zacks

access

search

I Earnings forecurting

Investment

Research now have increased

to these data, it is likely that future rewill rely more on individual

analyst data.

returns

Elton et al. (1981) provide evidence that investors cannot earn abnormal

returns by selecting stocks based on analysts consensus

growth

forecasts.

In contrast,

Givoly and Lakonishok

(1979), Abdel-khalik

and Ajinkya (1982), Hawkins et al. (1984), Freeman and Tse (1989), and

Beneish (1991) show that consensus analyst forecast revisions can bc used to predict subsequent

A potential

reason for the

abnormal

returns.

discrepancy

is that Elton et al. did not examine

forecast

revisions.

It would be instructive

to

investigate

whether

this is the reason for the

discrepancy

in results between

Elton et al. and

the other studies,

and if larger profits can be

made by using timely analysts forecasts,

those

pooled with time-series

model forecasts and/or

those

updated

using the Stickel (1990) procedure.

It also would

be interesting

to determine

whether

larger profits can be made by using

timely, or updated,

analyst estimates

in lieu of

the consensus estimate. Stickels (1991) evidence

may be instructive

in this regard. Showing that

the analysts

current

outstanding

forecast

is a

better measure of the markets earnings expectation, in the association

dimension,

than is an

updated forecast,

he uses this result to create a

profitable

trading strategy that predicts changes

in outstanding

forecasts.

Additional

research is

needed to reveal how and why analyst expectational data can be used to produce

abnormal

returns.

4. Earnings

4.1.

response

coefficient

literature

rc~earch

309

in accounting

earnings

to abnormal

stock returns [Easton and Zmijewski

(1989)]. The ERC

directly

links earnings

forecasting

research

to

capital markets

research because the definition

of earnings surprise is conditional

upon an earnings expectations

model. ERC studies often require a proxy for the earnings persistence

factor,

which relates changes in expected future earnings to current

earnings

surprise,

because,

in

theory, the valuation

implication

of an earnings

number

(the ERC) is positively

related to its

degree of permanence

(the earnings persistence

parameter).

Studies have not been uniform regarding the ARIMA

model chosen to estimate

the earnings persistence

parameter.

Some of the

assumed

ARIMA

models and their advocates

are: ARIMA

(O,l,l)

[Beaver

et al. (1980)],

ARIMA

(0,O.l)

[Miller

and

Rock

(1985)].

ARIMA

(2,1,(l) [Kormendi

and Lipe (1987)],

and

ARIMA

(1 ,O,O) [Ramakrishnan

and

Thomas

( 1992)].15 Surprisingly,

little work has

been done examining

the sensitivity

of ERC

estimates to alternative

ARIMA model specifcations. [See Kendall and Zarowin (1990) for some

limited

evidence

on this issue.] The external

validity of this research would be enhanced

(or

lessened)

considerably

by showing that the results are (or are not) robust

to alternative

ARIMA

model specifications.

Easton and Zmijewski

argue that the analysts

earnings

revision coefficient

(i.e. the coefficient

relating current earnings to analysts estimates of

future earnings)

is an explanatory

variable

of

ERC. They document

a positive association

betwecn the ERC and the analysts earnings revision coefficient,

and a negative association

be If earnings

can be modclled

as an AROMA process and

changes

in expectations

about future earnings

produce

dollar for dollar changes

in expectations

about future

dividends,

Flavin (1081) shows that the theoretical

ERC is

(I + persistence factor) where the persistence factor is:

The earnings

efficient relating

response

coefficient

is the cothe surprise (new information)

Elton

consensus

data. Abdel-khalik

and Ajinkya USC Merrill Lynchs Oprions Alert data. Givoly and Lakonishok

use Standard

and Poors Eumings

Fbrecouter data,

Hawkins et al. use I/B/E/S

consensus

data. aand Ben&h

uses analysts information

reported

in

the WuN Street Journals Heard on the Street column.

where 4, is an autoregressive

coefficient

moving average

coefficient

of order i;

orders

of the autoregressive

process,

moving average processes,

respectively;

of capital.

of order C; 0, is a

p. d and q arc

differencing

and

R is 1 + the cost

on the earnings

capitalization

model of Miller

and Modigliani

(1961) to test their hypotheses

that ERCs are increasing

in the revision parameter and decreasing

in risk. The revision parameter and risk are positively

correlated

with the

numerator

and denominator

of the earnings

capitalization

model, respectively.

The authors

include

firm size to control

for measurement

error in their proxy for unexpected

earnings and

not to test a hypothesis.

They use the analysts

consensus

(mean) earnings estimate to proxy for

expected

earnings

and current earnings surprise

to estimate the ERC. Both of these metrics may

need reconsideration

in light of recent evidence.

Regarding

the use of consensus

forecasts, the

evidence

of Brown (1991) and Brown and Kim

(1991) suggests that expected earnings and earnings forecast

revisions

may be sensitive

to the

utilization

of timely composite forecasts in lieu of

consensus

estimates.

With regard to the use of

current

earnings

surprise to estimate the ERC,

Bernard

and Thomas

(1990), Wiggins (1990).

and Bartov

(1992) show that abnormal

stockprice

movements

at the

time

of earnings

announcements

are related to current earnings

and the four most recent quarterly earnings numbers. Cornell and Landsman

(19X9) and Abdelkhalik (1990) show that forecast revisions provide incremental

explanatory

power in a regression of abnormal

returns

on earnings

surprise.

These

papers

use I/B/E/S

consensus

(mean)

forecasts and Value Line forecasts as proxies for

the markets

(unobservable)

earnings

expectation. Kothari

and Sloan (1992) show that the

ERC from a regression

of returns on contemporaneous

earnings

changes

is biased towards

zero and that the bias is mitigated

by including

leading-period

returns

in the ERC estimation

equation.

Thus, ERC studies confined to current

earnings

[e.g. Kormendi

and Lipe (1987), Collins and Kothari (1989), Easton and Zmijewski

(1989)]

are likely to suffer from an omitted

variable problem, causing inefficient and possibly

biased ERC estimates.

In summary.

ERC studies using a short window [e.g. Easton and Zmijewski

(1989)] require

a precise measure

of earnings

response.

(The

issue of narrow versus wide windows is discussed

further

in Section 4.3.) Additional

research

is

needed

to determine

whether

the results

of

studies modeling

ERCs are robust to ERC estimates incorporating

timely earnings

forecasts.

lagged quarterly

earnings,

revisions

of future

quarterly

earnings

and alternative

specifications

of the earnings

time-series

process.

4.2.

Determinants of ERG

Collins

and Kothari

(1989) find that ERG

increase in economic

growth and/or time-series

persistence

[Kormendi

and Lipe (1987)],

and

decrease

in interest rates and risk. Lipe (1990)

shows that the ERC is positively related to both

the predictability

of the earnings series and the

time-series

persistence

of earnings. The forecasting literature

as it pertains

to the time-series

properties

of earnings

is relevant to the Collins

and Kothari

(1989) and Lipe (1990) studies.

These studies, respectively,

assume, but do not

test, that the time-series

process of annual earnings follow an ARIMA

(O,l,l)

[Beaver et al.

( 19SO)] and ARIMA

(2,l .O) [ Kormendi

and

Lipe (1987)] process. However,

Lipe and Kormendi (1993) show that annual earnings follow a

fourth-order

autoregressive

process and that a

dollar of year t earnings

surprise

leads to an

approximately

8O-cent revision

in year t + 1

earnings.

The robustness

of the Collins and

Kothari (1989) and Lipc (1990) results to alternative definitions

of earnings persistence.

such as

the one advocated

by Lipe and Kormendi

(1993), awaits further research.

Brown and Zmijewski

(1987) find that ERCs

are smaller during strikes than at other times.

This finding is consistent

with the joint hypothesis that price-irrelevant

and transitory

earnings

are higher during strikes, and that the capital

market assigns a smaller multiplier to these earnings components

[Ramakrishnan

and Thomas

(1991)]. Collins and DeAngelo

(1990) find ERCs

to be higher during proxy contests

and lower

after proxy contests than at other times. They

consider the former result as surprising,

because

earnings

management

during

proxy

contests

should lower ERCs and the latter result as con Lipe and Kormendi consider the general ARIMA ( p,d,q)

model. set tl = I, q = 0. and focus on the effects of changing /7. the order of the ARIMA

(p.1.0) t~~odel.They

cstimnted

the parameters

for the first through tenth orderh. but found most of the improvements

to occur hy the

fourth order.

L. D. Brown

i Earnings

bath

after experiencing

management

changes [Elliott

and Shaw ( 19SS)]. Choi and Jeter ( 1992) show

that a firms ERC declines

significantly

after

issuing qualified

audit reports for a sample of

subject-to

and consistency

qualifications.

Their

results are consistent

with the hypothesis

that

audit qualifications

reduce the markets responsiveness to earnings

announcements

by altering

perceptions

of earnings noise and/or persistence.

These studies suggest that a temporal estimate of

a firms ERC should adopt a methodology

incorporating systematic non-earnings

shocks, such as

that employed

b.y Lee and Chen (1990).

Using the variance in analysts earnings forecasts, prior to a firms annual earnings announcements, to proxy for its ex ante uncertainty,

Imhoff and Lobo (1992) examine the effect of ex

ante earnings

uncertainty

on ERCs.

Finding

firms with relatively

high ex ante uncertainty

to

exhibit little or no systematic stock-price change

when earnings

are announced,

they conclude

that dispersion

in pre-announcement

analysts

earnings

forecasts proxies for noise in the earnings signal. However, Kim and Verrecchia (1991)

maintain

that expected stock-price

change is related to the resolution

of ex ante uncertainty,

not

to its amount.

The resolution

of uncertainty

is

related to both the amount of ex ante uncertainty and the precision

of the earnings

announcement. A commonly

used proxy for resolution

of

uncertainty

is the change in dispersion

of analysts earnings

forecasts

[Morse et al. (1991),

Brown and Han (1992)]. The robustness

of the

Imhoff and Lobo results should be examined

using the change in dispersion

of analysts earnings forecasts

at the time

of an earnings

announcement,

in lieu of the level of analyst

dispersion

prior to the announcement.

In summary,

ERCs are positively

related to

economic growth and/or time-series

persistence,

and negatively

related to interest rates and risk.

They are smaller when earnings

noise is high,

earnings

persistence

is low and ex ante uncertainty is high. The impact of the resolution

of ex

ante uncertainty

on ERCs awaits further study.

4.3. Functional

equation

Abdel-khalik

form

of the ERC

(199(l),

estimation

and

forecasting

research

311

Freeman

and Tse (1992) show that the relation

between abnormal

returns and unexpected

earnings is non-linear.

Abdel-khalik

(1990) shows

that a mode1 relating

abnormal

returns to unexpected earnings is better specified if it includes

the past and future revisions of earnings expectations in the estimation

equation.

Das and Lev

(1991) show that the non-parametric

procedure,

locally weighted

regression,

yields significantly

more explanatory

power

than ordinary

least

squares

(OLS) in an abnormal

return on unexpected earnings regression,

especially for small

earnings

surprises.

Freeman

and Tse (1992)

show that the marginal response of stock price to

unexpected

earnings

declines

as the absolute

value of unexpected

earnings increases.

Assuming that the absolute value of unexpected

earnings is negatively

related to earnings persistence

and that it is relatively easier to forecast permanent

earnings

than transitory

earnings,

they

maintain

that these two assumptions

imply that

transitory

earnings surprises are concentrated

in

the tails of the unexpected

earnings distribution.

Their evidence

is consistent

with the view that

the earnings-return

relation

is S-shaped

(i.e.

convex

for bad news and concave

for good

news).

Cheng et al. (1992) evaluate the specification

of the commonly

used method of estimating

the

ERC, namely

a linear regression

of abnormal

returns

on unexpected

earnings.

They include

three samples of earnings forecasts - the random walk mode1 forecast

and two sources of

analyst forecasts,

I/B/E/S

and Value Line and examine returns for both short (2-day) and

long (more than 1 year) event windows. Testing

for non-linearity,

heteroscedasticity,

residual

non-normality,

omitted variables and coefficient

variation

across firms, they generally

reject the

classical normal linear regression

model assumption (i.e. in almost all cases, they find the relation to be non-linear).

The Cheng et al. (1992)

and Freeman and Tse (1992) studies suggest that

ERC estimation

models based on the linearity

assumption

are misspecified

and may lead to

inconsistent

inferences.

Cheng et al. replicate

Cornell and Landsman

(1989), and find that the

specification

problems are severe enough to lead

to substantial

instability

in the linear regression

models inferences.

Their OLS analysis of Cornell and Landsmans

data revealed

problems

with heteroscedasticity,

non-linearity

and nonnormality.

The model with the ranked forecast

errors (the Cheng et al. approach)

produced

a

considerably

higher degree of coefficient stability, R, and larger t-values than the conventional,

unranked

forecast error approach

(used by Corncll and Landsman).

In contrast with Abdel-khalik

(19SO), Das and

Lev (1991) and Freeman

and Tse (1992), who

conduct

cross-sectional

and in-sample

analyses,

Beneish

and Harvey

(1993) conduct

temporal

and cross-sectional

analyses,

and provide fitting

and predictive

evidence.

Their temporal

and

cross-sectional

analyses

on seven models (one

linear. four non-linear

and two non-parametric)

suggest

that linear

models

arc inferior

when

using in-sample

data, but not when using out-ofsample data. Providing evidence that some of the

non-linear

models overfit the data. they suggest

that temporal

and cross-sectional

ERC changes

should be identified

with a methodology

that is

robust to influential

observations

(c.g. adaptive

non-parametric

regression).

Mendenhall

and Nichols (1988) find the ERC

response to bad-news earnings to depend on the

announcements

fiscal quarter. More specifically,

the ERC is greater for interim than for annual

(fourth

quarter)

reports.

Their results suggest

that ERC models should allow for differential

rcsponscs

to bad news for interim versus annual

earnings announcements.

However. their empirical tests arc incomplete

as they exclude goodnews earnings

[Palcpu (1%X)]. Additional

theoretical

development

and empirical

tests are

necessary

before definitive

conclusions

can be

drawn

Ohlson

(lC)Yla,b)

and Ohlson

and Shroff

(1992) argue that earnings levels, deflated by the

beginning-of-period

price, often arc more appropriate

than

are

properly

deflated

earnings

changes as proxies for unexpected

earnings when

modeling

rates of return.

Easton

and Harris

(1901) and Ali and Zarowin

(1992) use long

windows

(12-month

returns).

and provide cvidence consistent

with these models. Their tindings suggest

that long-window

ERC

studies

should include earnings

levels to appropriately

estimate

ERCs.

E&ton and Harris

earnings

Y.,lhfi,3/P,,

introduce

a multivariate

analysis

ot

,I +

,) + E!, where: R,,. return on a share of firm j

and Wild (1992) show that earnings

levels and

stock prices are more highly correlated over long

(4-10 years) windows than short ones (one quarter to 1 year). Kothari

(1992) also uses long

windows and examines

alternative

specifications

of ERC estimation

procedures

when stock prices

lead earnings.

He shows that when stock prices

impound

information

that is not reflected in the

time-series

of past earnings,

earnings levels provide relatively

more explanatory

power than

earnings changes (both deflated by beginning-ofperiod stock price). and that including

earnings

levels in the ERC estimation

equation

may lessen the ERC bias. The need for a precise cxpcctations model is diminished

when a long-window

approach

is used. With a longer window,

the

generally accepted accounting

principle (GAAP)

conservatism

problem is less severe because what

is reported

in financial statements.

via the realization

and matching

principles,

is more congruent with what is impounded

in share price.

In summary.

while the evidence

regarding

whether

the returns-earnings

relation

is nonlinear is mixed, the relation

is better specified

with both (appropriately

deflated) earnings levels

and changes than with earnings

changes alone.

The need for a precise earnings

expectations

model, such as recent analyst forecasts.

is less

important

when a long-window

approach is used.

Additional

research

is needed to ascertain

the

impact on ERC estimates of both the fiscal quarter and the nature of the news (i.c. whether it is

good or bad).

4.4. Stock-price

expectutions

md

earnings

eqectations

Bandyopadhyay

et al. (1993) examine whether

analysts incorporate

their earnings forecasts into

their stock-price forecasts and if the usefulness of

analysts earnings

forecasts for their stock-price

forecasts

is related to the length of their joint

stock price to earnings

forecast horizon.

They

show that analysts act as if earnings forecasts are

over

the

months

earnings

I2 months

after

extending

9 months

annual

from

I : E,,is

random

I: I,,

prior

to 3

accounting

,,

price pel-

error of firm j at

important

for their stock-price forecasts and that

earnings

are relatively more important

for price

in the longer term. Their finding that long-term

ex ante ERCs arc relatively greater than shortterm ex ante ERCs is consistent with Lev (1989),

Kothari and Sloan (1992), and Ohlson and Penman (1992), who show that long-term

ex post

ERCs

are relatively

greater

than short-term

ones. (Ex ante ERC studies relate expected returns to expected earnings;

cx post ERC studies

relate actual returns to actual earnings.)

There are two factors at work regarding

the

relation between the ERC and the length of the

horizon.

On the one hand, GAAP conservatism

suggests a higher ERC when the joint earnings

and price horizon is lengthened

because cumulated reported

earnings

include relatively

more

of what is impounded

in price. On the other

hand, the ERC over the life of the firm (birth to

death) is 1.0. As a longer horizon is more akin

to the life of the firm, the ERC may be smaller

over a longer horizon (i.e. it may approach

1.0

asymptotically

from above).

Consistent

with

Levs (1989) argument

that GAAP conservatism

in measuring

earnings causes stock prices to lead

accounting

earnings,

the Bandyopadhyay

et al.

(1993) evidence

suggests that non-earnings

information

is relatively

more

important

for

shorter-term

price estimates.

However,

Bandyopadhyay

et al. (1993) are silent regarding the

nature of the non-earnings

information,

and they

do not say how analysts stock-price

forecasts,

earnings forecasts and non-earnings

forecasts relate to the capital markets expectation

of these

variables.

Govindarajan

(1980) uses content analysis to

examine

the importance

given by security analysts to earnings

versus cash flows when they

make their recommendations.

Security analysts

comments

on companies

in 976 reports were

scrutinized

using the Wall Street Transcript, and

rated from one to six, according to the authors

interpretation

of the commentary,

as follows: (1)

no mention

of earnings,

(2) earnings analysis is

less important

than cash flow analysis, (3) earnings analysis and cash flow analysis are equally

important,

(4) earnings

analysis

is more important

than cash flow analysis,

(5) earnings

analysis only, except for mention

of dividends

and (6) no mention of cash flows. Security analysts attached more weight to earnings than cash

of reports

examined.

Consistent

with Bandyopadhyay

et al.

(1993), Govindarajan

(1980) finds earnings to be

an important

source of analysts recommendations. In contrast,

Bouwman

et al. (1987) use

protocol analysis and conclude that income statements do not play a dominant

role in analysts

selection of investment

candidates.

More specifically, the authors provided professional

financial

analysts

with a package

of financial

materials

that reflected

the magnitude

and types of information

they normally

review when screening

prospective

investments.

The

analysts

were

asked to verbalize whatever came to mind during their evaluations.

The authors resulting transcripts. called protocols,

served as the basis for

their analyses.

In summary,

capital markets research suggests

that analysts incorporate

their earnings forecasts

into their stock-price

forecasts

and that their

earnings forecasts are relatively more important

for their stock-price

forecasts in the longer term.

The evidence from behavioral

research regarding

the importance

of earnings

forecasts

is mixed.

Little is known from either branch of research

about the way in which analysts formulate

their

stock-price

forecasts

or about the role of accounting

and non-accounting

information

in this

process.

capital markets/earnings

forecasting areas

Sections 2 to 4 discuss numerous

directions for

future research so this section discusses only a

few such directions.

Several studies have examined

the relation

between

analysts earnings

forecasts and firm-specific

factors, such as stock

prices, changes in consensus

earnings estimates,

deviation from the consensus and forecast errors.

However,

with limited exceptions

[Stone (1977),

Fildes and Lam (1990)], the macroeconomic

and

industry

factors asserted by analysts to be important

cues to their decisions

have been ignored.

This appears

to be a fruitful area for

future

research.

Moreover.

there has been a

scarcity of research examining

linkages between

analysts stock-price

forecasts and other factors

of interest

(e.g. earnings

forecasts,

past stock

prices, and macroeconomic

and industry data).

but

are inputs

into stock

recommendations

[Schipper (1991)], future research should explore

these linkages.

A second direction

for future research

is to

link post-earnings

announcement

drift with convergence of analysts earnings expectations.

Bernard and Thomas (1990) suggest that drift is a

delayed

response

to information.

Verrecchia

(1980) argues that the rapidity

of stock-price

adjustment

to information

increases as the precision of the information,

as determined

by the

consensus judgment

of investors, increases. If so,

drift should be most evident when analysts forecasts converge

slowly after earnings

announcements. This issue should be addressed

using

individual,

rather than consensus,

analysts earnings forecasts,

allowing the researcher

to ascertain if the forecast is made conditional

upon a

particular

earnings announcement.

A third direction

for future

research

is to

examine

the role of analysts forecasts if capital

markets are efficient compared

with their role if

capital markets are inefficient.

If capital markets

arc informationally

efficient in the conventional

sense, and if the analyst is the market. forecast

accuracy and market association

are two sides of

the same coin, and the role of analysts is rather

limited. More specifically,

in this case, a composite of analysts (and perhaps other) forecasts can

proxy for the markets (unknown)

earnings

expectation

and examination

of the analysts expectation formulation

process is not especially informative. However.

if capital markets are not efficient in the conventional

sense, the role of analysts forecasts

is much broader,

provided

that

analysts

are reasonably

efficient

processors

of

financial information

and stock prices ultimately

reflect fundamentals.

In a return to the world of

Graham

et al. ( 1962), analyst behavior

merits

investigation

to determine

how fundamental

The relation

hetwcen

post-earnings

announcement

drift

and the rapidity of convergence

of analysts expectations

is

best examined for positive earnings surprises. Stock prices

should he lower when uncertainty

is heightened

[Vxian

(19X5)], unconditional

on the sign of the earnings surprise.

Thus. stock prices should drift upwards

after earnings

announcement

drift for both good news and bad news. An

increase

in stock prices owing to uncertainty

resolution

may provide an explanation

for positive earnings surprises

being followed by positive drift.

financial statement

analysis can be used to detect

mispricing.

[Lev and Thiagarajan

(19YI), Penman (1992~). and others have recently advocated

a return

to fundamentals.]

Such research

should examine how (and why) analysts use (and

ignore) certain financial statement

data.

The manner

in which analysts

use/neglect

earnings

and non-earnings

information

is crucial

for a better understanding

of how stock prices

are formulated.

If capital markets

are not informationally

efficient, it is important

to understand how analysts

process earnings

and. nonearnings

information

to estimate intrinsic value,

which is not necessarily

impounded

in stock

price. Behavioral

research,

which has played a

limited role to date in understanding

how analysts formulate

their expectations,

is likely to play

a more prominent

role in the future.

6. Implications

areas

for forecasting

research

in other

literature

has

developed

a number of themes which have been

addressed

by the literature

surveyed

in this

paper. Some of these themes are: (i) the ex ante

comparison

of accuracy and the stability of models out-of-sample:

(ii) the choice of error measure and if the particular

error measure chosen

matters; (iii) the comparative

analysis of method

performance

using comparable

information

sets;

(iv) heuristics

and biases of judgment

and their

incompatibility

with rational expectations.

It has been shown that complex earnings forecasting models often fail in out-of-sample

comparisons

[Albrecht

et al. (1977).

Watts and

Leftwich

(1977).

Foster

(1977),

Beneish

and

Harvey

(1993)].

It is easy to over-identify

a

structural

model using in-sample

data, but simpler models have proven to be more robust in

holdout periods. It appears that Ockhams razor

is valid - parsimonious

models often are preferable to complex ones.

With accounting

data, the choice of error measure is important,

as the denominator

can be

close to zero or even negative [Lev and Sunder

(1979), Frecka and Hopwood ( 1983)]. Thus, the

results of parametric

tests may rely heavily on

outliers.

In order to reduce the outlicr problem,

many studies

deflate by stock price [Christie

L. D. Brown

non-parametric

tests [Brown and Rozeff (1978)].

Earnings forecasting

research has occasionally,

but not often, provided comparative

analyses of

method

performance

with comparable

information sets. For example,

Brown et al. (1987~)

provide similar findings with each of two sources

of analysts

earnings

forecasts.

However,

the

ERC literature

has typically

provided

results

conditional

upon a particular

assumed

timeseries process. Given the unfortunate

aversion to

replication

in the social sciences (cf. the hard

sciences where replication

is the norm), it behooves social science researchers

to provide results with multiple data sources.

The earnings forecasting

literature

has recently, but belatedly,

begun to examine

heuristics

and biases of judgment,

and its incompatibility

with rational expectations

[Affleck-Graves

et al.

(1990), Ah et al. (1992), DeBondt

and Thaler

(1990)]. This research is still in its infancy. Joint

efforts by capital market

researchers

and behavioralists

to examine

these issues more thoroughly would considerably

enhance

our understanding

of the role of analysts

in the price

formation

process.

Earnings

forecasting

research appeared

to be

at a dead end in the late 1970s. Annual earnings

were known to follow a random walk with drift

process,

except when annual

earnings

changes

were extreme,

and three univariate

ARIMA

models of the quarterly earnings time-series process were introduced.

Little work has been done

since the late 1970s to develop more accurate

time-series

models. Two events transpired

in the

late 1970s which provided an impetus for earnings forecasting

research.

First, analysts earnings forecast

data became readily available

in

machine-readable

form. Second, capital markets

research

began to look to forecasting

research

for proxies of the (unobservable)

market earnings expectation.

Earnings

forecasting

research

has flourished

since its use of analyst expectational

data and its

linkage

to capital markets

research.

Increased

information

availability,

via analysts

earnings

estimates,

and increased

focus on information

usage, via the capital markets, has greatly aided

earnings

forecasting

research.

Other disciplines

utilizing

forecast data may be able to sharpen

their intellectual

foci and broaden their perspec-

availability

and information

usage.

31s

information

References

Abarbanell.

J.S., 1991. Do analysts earnings forecasts incorporate

information

in prior stock price changes?,

Journul of Accounting und Economics, 14, 147-165.

Abarbanell,

J.S. and V.L. Bernard,

1992, Tests of analysts

overreactioniunderreaction

to earnings information

as an

explanation

for anomalous

stock price behavior,

Journul

of Finance, 47, 1181-1207.

Ahdel-khalik,

A.R.,

1990, Specification

problems

with information

content of earnings:

revisions and rationality

of

expectations

and self-selection

bias, Conternporq

Accounting Research, 7. 142-172.

Abdel-khalik.

A.R. and B.B. Ajinkya.

19X2, Returns

to

informational

advantages:

the case of analysts

forecast

revisions.

Accounting Review. 57. 661-680.

AfHeck-Graves.

J., L.R. Davis and R.R. Mendenhall,

1990.

Forecasts

of earnings per share: possible sources of analyst superiority

and bias, Contemporary Accounting Review. 6. 501-517.

Ajinkya.

B.B. and M.J. Gift, 1985, Dispersion

of financial

analysts earnings forecasts and the (option model) implied

standard

deviations

of stock returns,

Jourrrul of Finance.

40. 1353-1365.

Albrecht.

W.S., L. Lookabill

and J. McKeown,

1977, The

time series properties

of annual

earnings,

Journal of

Accounting Re.yeurch. IS, 226-244.

Ah, A. and P. Zarowin,

1992. The role of earnings levels in

annual earnings-returns

studies,

Journal of Accounting

Research, 30. 2X6-296.

Ah, A.. A. Klein and J. Rosenfeld,

lY92. Analysts

use of

information

about permanent

and transitory earnings components

in forecasting

annual EPS, Accounting Review,

67, 183-398.

Ashton, A.H. and R.H. Ashton,

1985, Aggregating

subjective forecasts:

some empirical

results,

Management Science 1 31 . 1499%1508.

Atiase, R.K.. 1985, Prcdisclosure

information.

firm capitalization,

and security

price

behavior

around

earnings

announcements.

Journal of Accounting Research. 23. 2136.

Ball. R., 1992, The earnings-price

anomaly,

Journul of

Accounting und Economics, 15, 319-345.

Bail. R. and P. Brown, 196X. An empirical evaluation

of

accounting

income numbers.

Journal of Accounting Research. 6, 159-178.

Bail. R. and R. Watts, 1972, Some time series properties

of

accounting

income, Journal of Finunce, 27, 663-681.

Bamber,

L.S.. 1987, Unexpected

earnings,

firm size, and

trading

volume

around

quarterly

earnings

announcements, Accounting Review, 62, 510-532.

Bandyopadhyay.

S.P., L.D. Brown and G.D. Richardson,

1993, The importance

of analysts earnings forecasts

to

their stock price forecasts,

Working paper, University

of

Waterloo.

Bartov.

E.,

IYY2.

cxplanatirm

Ikll.

Patterns

in unexpected

for post-announcement

earnings

drift..

as an

Accoutttin~

Rr-

67. 610-622.

Bathkc.

Jr. A.W.

between

Lorek.

models

of quarterly

lY84.

The

relationship

earnings.

markets

A~outt/it~g

ex-

Re~~ir~~, SY.

163-176.

Beaver.

W. and D.

Morse.

ratios?,

W.H.,

W.H..

R.A.

information

D.

price-

33. 65-76.

Morse.

prices.

1080.

Journul

The

of

AC

mrl

and S.G.

Ryan.

prices:

Economics.

1087,

a second

The

look.

Y. 13Y- 157.

M.D.

and C.R.

the earnings-return

Harvey.

1993. The

relation,

Working

specification

paper.

Duke

of

Un-

versitv.

G.J.

and R.L.

of earnings.

Bernard,

mium?.

Bernard.

Watts.

Working

V.L.

and

announcement

Jourrtul

V.L.

paper.

J.K.

drift:

197X. The

University

Thomas,

delayed

for

future

EcotKttnic.s,

Bhushan.

ing,

response

R..

Jourrwl

of

carn-

Accorrt~fit~g

of

G.C.

characteristics

und

Accounting

and W.E.

anti

Ricks,

Economic~.s.

1988, Analyst

Journal

adopters.

1 I, 255-274.

forecast errors

dates of LIFO

announcement

of Accounring

Rcwurch.

l(,Y-194.

Bouwman,

P. Frishkoff

analysts make

investment

and P. Frishkoff.

decisions!

screening decision.

lYX7. How

do

Accounting.

Orqmizurions

G.E.P.

and

Francisco.

CA).

Branson,

B.C.

prediction

2nd edition

Anrrl,vsi.v:

(Holden-Day.

San

of

D.P.

Pagach.

earnings

Working

IV%.

per

paper

Examination

share

(North

and

forecast

Carolina

origin

State

Uni-

versity).

Brennan,

M.J.

supply of information,

Brooks.

L.D.

and

Journul

D.A.

IYYI.

of

Journd

of Fimmce.

L.D..

lY76.

Further

evi-

income.

31. 1359-1373.

L.D.

on Accounting

Brown.

L.D.

earnings

liefs.

all forecasts

of Forecusr-

Griffin

(Editors).

IY8.1. Special

Issue

and Forecasting.

and

J.

Han.

announcements

Accounting

L.D.

and M.S.

Review.

and K.J.

Kim.

Journul of Forecasting.

2.

lYY2. The impact of annual

on convcrgencc

of analysts

be-

of

The

33.

of

evidence

l-16.

lY7Ya.

of

superiority

expectations:

Finunw.

IJnivariate

time

Accounting

Timely

aggrcgatc

analyst

Rozeff,

of i2crounling

of interim

reports

terly earnings.

Brown,

L.D.

Rrsearch.

R~.wrtdt.

labor

Accounring

and

17.

.wrtrdt.

between

value

of future

quar-

1.

can forecast

Munagettwn/,

1087,

risk-adjusted

6. 31-34.

The

effect

superiority

of

and

Conternporary

Accounting

Rc-

3. 61-75.

L.D..

jcwski.

P.A.

IYX7a.

univariatc

P.A.

lYX7b.

the markets

ttrg crtd

Brown.

Griffin,

An

to

earn-

Y, 6147.

and M.E.

Zmi-

proxies

for

of Auvutl/-

Journul

Y. 159-193.

and S.J. Schwager,

interpretation

in forecasting

L.D..

ti.D.

Strong-term

counting

of

earnings.

1087~.

financial

Journal

Richardson

efficiency

and C.A.

on the Toronto

analyst

of Accounting

Trzcinka.

IYYI.

stock exchange:

Conkmporury

an

AC,-

Rc.wurc~h, 7. 32%5th.

Ywr

Eurning.s

(American

Forecrrsrs

Accounting

K.C.

Association,

and L.H.

Lang.

analysts:

evidence

pessimism

. .lournul

of Accounting

C.S.A..

Non-linearity

earnings

W.S.

19X5. Swuri/y

und

individual

Chcny.

quarterly

of alternative

of earnings.

Zmi-

relative

. 25. -1%67,

R~scwrch

Brown.

Hagerman

Richardson

information

Brown.

and M.E.

superiority

and Economics.

R.L.

evaluation

Economic.s.

G.D.

Hagerman

analyst

models in forecasting

expectation

L.D..

An

R.L.

ofAccounfing

L.D..

jewaki.

Griffin.

Security

timc-series

ings. Journd

Butler.

I.

54. X-59

analysts forecast

earnings,

revision,

predictive

1980, Analysts

Zmijcwski,

strikca on security

unexpected

forecasts

of Iortfolio

cxpecta-

forecast

The

Rrvirw,

Rozcff,

M.E.

Adaptive

17, 311-X

1970,.

for improving

Journul

L.D.

lY7Yh.

and analyst

Rozeff.

and M.S.

accurately!.

the

Cupid

Sarasota.

Anu/y.sl

Market

FL).

of systematic

Hopwood

and specification

optimism

Rwwch.

and J.C.

McKcown.

problems

and

lYY2.

in unexpected

AccowfitzgKcview.

67. 57%5Y8.

S.K.

and D.C.

Jetcr.

audit opinions

on earnings

oj Accounting

und

A.A..

ing research.

lYY2, The

Economics.

of

of qualified

Jourflnl

IS. 22Y-247.

1987, On cross-sectional

Journd

effects

response coefficients.

Axounting

analysis in accountund

Econotnic.~.

Y(

231-258.

Coggin, T.D. and J.E. Hunter. 198.3. Problems in measuring

the quality of investment information: the perils of the information

67, X62-875.

IYYI.

between

68. 668-W).

accounting

models.

Christie.

and P.A.

cxpecta-

29, 382-1X5.

association

1078.

Rozeff,

Journal

timeseries

Brown.

Choi.

recent. Internationd

Journul

7, 34Y-356.

Brown.

Brown.

10. 166%16YI.

of accounting

1901.

ing,

Stock

Finance.

Buckmaxter.

Brown.

L.D.

tions,

Mulri-

and

superiority,

Jenkins,

Control,

M.S.

model,

examination

and G.M.

Fotwasting

of

Journal

and

superiority

M.,

financial

Box.

that stock

of current

untl

Brown.

Brown.

IYXY, Firm

Rozeff.

Brown.

27. I-38.

IYYO. Evidence

26.

or risk prc-

13. 305-330.

Journd

Biddle.

earnings.

1993. The

as measures

on the association

Post-earnings-

Resmrch.

Thomas,

forecast

of Rochester.

lY8Y.

price

of Accout~tinl:

and J.K.

markets

ings

L.D.

proposed

earnings

Research,

RwiCw.

M.S.

from earnings.

Brown.

Bcnston.

Kim.

Accounfing

and

forecasts

Brown.

for market

L.D.

Journd

IYYI.

analysts recommend~ltiona,

Journal of Busitwss. 64. 3Y3416.

Bcncish.

and K.J.

mal returns.

Brown.

proxies

of Accounting

17Y-l8Y.

of security

.Iorrrtlcrl of Accourr/itqy

Journul,

2. 3-2X.

Lambert

content

M.D..

and

of security

Ecotwrnic.s.

detcrmincs

Anulysts

Lambert

content

trrd

Ben&h.

lY7X. What

Financiul

R.A.

information

cour1ring

Beaver.

L.D.

nonearnings

analyst

earnings

Beaver.

as better

. Journul

Brown.

and K.S.

time-series

pectation

forecasts

tions

33.

coefficient.

Finuncd

Analysts

Jourturl,

39.

2S-

L. D. Brown

Collins.

D.W. and L. DeAngelo.

1990. Accounting

information

and corporate

governance:

market and analyst

reactions

to earnings of firms engaged in proxy contests.

Journal of Accounting and Economics. 13. 213-247.

Collins. D.W. and S.P. Kothari,

1989. An analysis of intertemporal

and cross-sectional

determinants

of earnings response

of

Accounting

and

coefficients,

Journal

Economics, 11, 143-181,

Collins. D.W., S.P. Kothari and J.D. Rayburn,

1987, Firm

size and the information

content of prices with respect to

earnings.

Journal of Accounting and Economics, 9, 1 I l138.

Collins,

W.A. and W.S. Hopwood,

1980, A multivariate

analysis of annual earnings forecasts generated

from quarterly forecasts

of financial

analysts and univariate

timeseries models. Journal of Accounting Research. 18. 390406.

Collins,

W.A., W.S. Hopwood

and J.C. McKeown,

1984,

The predictability

of interim earnings

over alternative

quarters,

Journal of Accounting Research. 22. 467-479.

Conroy,

R. and R. Harris,

1987. Consensus

forecasts

of

corporate

earnings:

analysts

forecasts

and time series

methods,

Management Science, 33, 725-738.

Copeland,

T. and D. Maycrs, 1982. The Value Line enigma

(lY6551978):

a case study of performance

evaluation

issues. Journal of Financial Economics, 10, 289-322.

Cornell,

B. and W.R. Landsman,

1989, Security

price response to quarterly

earnings announcements

and analysts

forecast revisions.

Accounting Review, 64, 680-692.

Das, S. and B. Lev. IYYI. Evidence on the nonlinearity

of

the returns-earnings

relation,

Working paper (University

of California,

Bcrkelcy).

DeBondt.

W.F., 1993, Betting on trends: intuitive forecasts

of financial risk and return, International Journul of Forecasting. 9, 3555371.

DeBondt.

W.F. and R.M. Thaler,

1990. Do security analysts overreact?.

American Economic Review, 80. 52-57.

Dimson, E. and P. Marsh, 1984, An analysis of brokers and

analysts unpublished

forecasts of UK stock returns, Journul of Finance. 39. 1257-1292.

Dorfman.

J.R., 19Yl. Analysts

devote more time to selling

as firms keep scorecard on performance,

Wull Street Journal. 29 October,

Cl-2.

Dugar, A. and S. Nathan,

1992. The effect of investment

banking relationships

on financial analysts earnings forecasts and investment

recommendations.

Working paper

(Michigan

State University).

Easton. P.D. and T.S. Harris. 1991, Earnings as an explanatory variable for returns, Journal of Accounting Research,

2Y, 19-36.

Easton.

P.D. and M.E. Zmijewski,

1989, Cross-sectional

variation

in the stock market response to accounting

earnings

announcements.

Journal

of Accounting

und

Economics, 11, 117-141.

Easton,

P.D.. T.S. Harris and J.A. Ohlson,

1992, Aggregate accounting

earnings

can explain

most of security

returns:

the case of long event windows,

Journal of

Accounting and Economics, 15. llY-142.

Elgers.

P. and D. Murray,

1992, The relative and complementary

performance

of analyst

and security-pricebased measures of expected earnings,

Journal of Accounting and Economics, 15, 303-316.

317

as accounting

procedures

to manage perceptions,

Journal of Accounting

Resettrch. 26, Yl-119.

Elton, E., M. Gruber and M. Gultekin.

1981, Expectations

and share prices. Management Science, 27, Y75-987.

Elton,

E., M. Gruber

and S. Grossman,

1986. Discrete

expectational

data and portfolio performance,

Journul of

Finance, 3. 609-712.

capital markets:

a review of

Fama, E.F..

1970, Efficient

theory and empirical work, Journal of Finance. 25. 383417.

Fildes, R. and K. Lam, 1990, Efficient

use of information

by financial analysts in the formation

of short term earnings forecasts,

Working

paper

(Manchester

Business

School).

Flavin, M.. 1981, The adjustment

of consumption

to changing expectations

about future income, Journul of folifical

Economy. 8Y, 974-1009.

Foster,

G., 1977. Quarterly

accounting

data: time-series

properties

and predictive-ability

results,

Accounting Revjiew. 52. l-21.

Foster, G., 1986. Financial Statement Analysis, 2nd edition

(Prentice-Hall,

Englewood

Cliffs. NJ).

Foster.

G., C. Olsen and T. Shevlin.

lYX4, Earnings

releases, anomalies.

and the behavior

of security returns,

Accounting Review. 59, 574-603.

Francis. J. and D. Philbrick,

1992, The association

between

Value

Line earnings

forecasts

and Value Line recommendations,

Working paper (University

of Chicago).

Frecka,

T.J. and W.S. Hopwood,

1983. The effects of

outliers on the cross-sectional

distributional

properties

of

financial ratios, Accounting Review. 58, 115128.

Freeman,

R.N., 1987, The association

between accounting

earnings

and security returns for large and small firms,

Journttl of Accounting tmd Economics. 9, 1955228.

Freeman,

R.N. and S.Y. Tse, 198Y, The multiperiod

information

content

of accounting

earnings:

confirmations

and contradictions

of previous earnings reports,

Journal

of Accounting Reseurch. 27. 4Y-84.

Freeman.

R.N. and S.Y. Tse, lYY2, A nonlinear

model of

security price responses

to unexpected

earnings,

Journal

of Accounting Research. 30. 1X5-209.

Freeman,

R.N..

J.A.

Ohlson,

and S.H. Penman.

19X2,

Book rate-of-return

and prediction

of earnings changes:

an empirical

investigation,

Journal of Accounting Research, 20. 639-653.

Fried, D. and D. Givoly, 1982, Financial

analysts forecasts

of earnings:

a better surrogate

for market expectations,

Journul of Accounting and Economics, 4, 85-107.

Gilovich,

T., R. Vallone and A. Tversky,

1985, The hot

hand in basketball:

on the misperception

of random scquences,

Cognitive Psychology,

17, 295-314.

Givoly,

D.,

1985,

The

Formation

of

Earnings

Expectations.

Accounting Review, 3, 372-386.

Givoly. D. and J. Lakonishok,

1979, The information

content of financial analysts forecasts of earnings:

some evidence on semi-strong

inefficiency,

Journal of Accounting

und Economics. 3, 1655185.

Govindarajan,

V., 1980. The objectives

of financial statcmerits: an empirical

study of the use of cash flow and

earnings by security analysts,

Accounting, Orguniztttions

and Society. 5, 383-392.

Graham.

B..

Irincipks

rmd Techniques.

4th edition (McGraw-Hill,

Ncu

York, NY).

Grcig.

A.C..

1002. Fundamental

analysis and subsequent

stock returns.

Journd

of Accounring

cmd Economic.v.

15.

4 I3-J-12.

11unce. 5. 330-368.

Hopwood.

W.S.. J.C. McKeown and P. Newbold,

19X2. The

additional

information

content

of quarterly

earnings

rcporth: intertemporal

disaggregation.

Journd

of Accow~ting Re.wcrrc~h. 20. 343-339.

between

Hughes.

J.S. and W.E. Ricks, lY87. Associations

forecast

errors

and excess

returns

near

to earnings

announcements,

Accounting

Ret+w.

62. 15X-175.

Hunter. J.E. and T.D. Coggin. 1YXX.Analyst judgment:

the

efticicnt market hypothesis versus a psychological

theory of

Orpnizuiiond

Behavior

und Human

human judgment.

lIeci.tion

Processes. 42, 2X4-302.

Imhoff. E.A. and G.J. Loho. lYY2, The effect of cx ante

carninga

uncertainty

on earnings

response

coefficients,

Rrvie~~,

67. 427-439.

Joy. 0..

R. Litzcnherger

and R. McEnally.

1977. The

adjustment

of stock prices to announcements

of unanticipated changes in quarterly

earnings.

Journal of Accounring Rrseurch,

1.5. 207-225.

Kant.

A.. Y.K. Lee and A. Marcus.

1083. Earnings

and

dividend announcements:

is there a corroboration

effect?.

Jourd

of Finance. 30, lOYl-1OYY.

Kendall.

C.S. and P. Zarowin.

1990. Time-series

models of

earnings

persistence

and earnings

reannual

earnings,

sponse

coefficients.

Working

paper

(New York University).

use of maniiKim. K. and D. Schroeder.

IYYO. Analysts

gerial bonus incentives in forecasting

earnings.

Journul of

A~ounfing

und Economics.

13, 3-23.

Kim. 0. and R.E. Vcrrecchia.

1991, Trading

volume and

price reactions

to public announcements.

Journd

of Acwunring

Reseurch, 20, 302-321

Klein, A.. IYYO. A direct test of the cognitive bias theory of

share

price

reversals.

Journul

of

Accounting

and

Economics.

Kormcndi.

earnings

specifications

Accounting

und

and alternative

EconomicA.

deflators.

Journal

of

15, 173-202.

Kothari.

S.P. and R.G. Sloan, 1992. Information

in prices

about future earnings:

implications

for earnings response

cocfiicients,

Jownal

of Accounfing

cd

Economics,

143171.

Gritfin.

P.A.. lY77. The timeseries

behavior

of quarterly

earnings:

preliminary

evidence,

Jownd

of Accmrrriing

Rrseirrc~h

. 15. 7 l-83.

Gucrard.

Jr. J.B..

IYXY. Combining

time-series

model

forccasts

and analysts

forccnsts

for superior

forecasts

of annual earnings.

Fincmcid

Ancr~yvts Journtrl.

35. hY71.

Hawkins.

E.. S.C. Chamberlain

and W.E. Daniel.

IYX4.

Earnings

expectations

and security

prices.

I:incl,~c,itrl

Anulvs/s Jourrrd.

74. 24-29,

30-38. 74.

Holthausen.

R.W. and D.F. Larcker.

IYYZ, The prediction

of stock rcturna

using financial

statement

information.

Jolrnicrl of Accounting

and Economics.

15. 373-41 I.

Hopwood,

W.S. and J.C. McKeown.

1YYO. Evidence

on

surrogates

for earnings cxpcctations

within a capital marJournd

of Accounting,

Auditing

cmtl Fiket context.

Accounting

change

13. ISS-166.

innovations.

pcrsistcnce.

and stock returns.

Journul of Bu.riness, 60. 323-346.

regressions

in the preaKothari.

S.P., lYY2. Price-earnings

cnce of prices lading

earnings:

earnings

level versus

1990, Earnings

cxpectationc: the analysts

information

advantage,

Accounting

Rrtiew.

6.51 461-476.

Lee. C.W.J. and C. Chcn, IYYO. Structural

changes and the

forecasting

of quarterly

accounting

earnings in the utility

industry.

Journd

of Accounfing

und Economic.s.

13. Y3122.

Lcv. B., IYXY. On the usefulness of earnings and earnings

research:

lessons and directions

from two decades of empirical

research.

Journd

of Accounting

Resrurch.

27.

15%201.

lY79. Methodological

issues in the

use of financial

ratios.

Journul

of Accounting

rmd

Ecollomic~s.

I,

1X7-2 10.

lY91, Fundamental

information

analysis.

Working paper (University

of California. Berkeley).

Lev, B. and T. Sougiannis.

IYY2. The capitalization,

amortiLation.

and value-relevance

of R&D.

Working

paper

(University

of California,

Bcrkelcy).

.ibhy. R. and R.K. Blashficld.

1978. Performance

of a

composite

as a function of the number of judges. Orpnizut~onul

Behavior

und Humun

Performance.

21,

l21-12Y.

1YYI, Underwriting

relationships and analysts

earnings

forecasts.

Working

paper

(Stanford

University).

.ipe. R.. lYY0, The relation

hetwcen

stock returns and

accounting

earnings

given alternative

information.

Acwrtnring

Reviebv,

65. 49-7

1993. The implications

of the

higher-order

properties

of annual

earnings

for security

valuation,

in: S. A. Butler (Editor).

Earnings

Qudity

(University

of Oklahoma,

Center for Economic

and Management

Research),

142-168.

Little. I.M.D.. 1Yh2, Higgledy

piggledy growth. Blrlletin

of

the Oxford

342.

Institute

of Economics

and Stutisrics.

24. MY-

methods of combining sccurity analysts

and statistical

forecasts

of annual corporate

earnings,

Internutionnl

Journal

of Forecusting,

7. S7-63.

Lorck.

K.S..

lY79, Predicting

annual

net earnings

with

quarterly

earnings

time-series

models.

Journul

of Accounting

Resecrrch. 17. 190-204.

Lys. 7. and S. Sohn. IYYO, The association

between rcvisions of financial analysts earnings forecasts and sccurityprice changes.

Journd

o,f Accounting

und Economic.s,

13.

34

l-363.

financial analysts,

Accounfing

Review. 62, 176-182.

Mendenhall.

R.R.. 1991. Evidence

on the possible underweighting of earnings-related

information,

Jourrlul of Accounting

Reserrrch ~2Y. 170- 179.

Mendenhall,

R.R. and W.D. Nichols, lY88. Bad news and

differential

market reactions to annouhcements

of carlierquarters

versus fourth-quarter

earnings,

Journal

of Accounting

Resewch,

26. 63-86.

L. D. Brown

I Earnings forecasting

Miller.

M. and M. Modigliani.

1961, Dividend

policy.

growth, and the valuation of shares, Journal of Business.

34. 41 l-433.

Miller.

M. and K. Rock.

198.5. Dividend

policy under

asymmetric

information.

Journal of Finance. 40. 10311052.

Morse.

D., J. Stcphan

and E. Stice,

1991, Earnings

announcements

and the convergence

(or divergence)

of

beliefs, Accounting Review, 66, 376-388.

Muth, J.F.. 1961. Rational

expectations

and the theory of

price movements.

Econometrica,

29, 315-335.

Newbold,

P., J.K. Zumwalt and S. Kannan,

lY87. Combining forecasts to improve earnings per share prediction:

an

examination

of electric utilities.

International

Journal of

Forecasting,

3. 220-238.

OBrien,

P.. 1088. Analysts

forecasts as earnings expcctations, Journal of Accounting and Economics, 10. 53-83.

OBrien.

P.. 19Y0, Forecast

accuracy of individual analysts

in nine industries.

Journal of Accounting Research. 28,

286-304.

OBrien.

P. and R. Bhushan.

IYYO. Analyst

following and

institutional

ownership.

Journal of Accounting Research 1

2x. 55-76.

Ohlson,

an introduction

to the Ball-Brown

Analysis.

Confernporury Accounting Research, 8, I-19.

Ohlson, J.A., lY91h. Earnings,

book values, and dividends

in security

valuation.

Working

paper (Columbia

University).

Ohlson.

J.A. and S.H. Penman,

1092, Disaggregated

accounting data as explanatory

variables for returns.

Journcrl of Accounting. Auditing and Finance. 7. 553-573.

Ohlson. J.A. and P.K. Shroff, 1992, Changes

versus levels

in earnings

as explanatory

variables

for returns:

some

theoretical

considerations,

Journal

of Accounting

Research.

30. 210-226.

J. A..

accounting

numbers

as earnings

Ou.

Accounting

Ou. J.A.

analysis

Research.

content of nonearnings

predictors,

Journal of

28. 144-163.

S.H. Penman.

1989a, Financial

statement

the prediction

of stock returns,

Journal of

Accounting and Economics, 11, 295-329.

Ou, J.A. and S.H. Penman.

lY89b. Accounting

measurement. price-earnings

ratio, and the information

content of

security prices, Journal of Accounting Research. 27. 11 I1.52.

Palepu. K.. 1988, Discussion

of bad news and differential

market reactions to announcements

of earlier-quarters

versus fourth-quarter

earnings.

Journal of Accounting

Research,

and

and

26, X7-90.

Penman,

S.H..

lY92a. The articulation

of price-earnings

ratios and market

to book ratios and the evaluation

of

growth.

Working paper (University

of California,

Bcrkeley).

Penman,

S.H., 1992b, Financial

statement

information

and

the pricing of earnings changes,

Accounting Review. 67.

563-577.

Penman.

319

research

Ramakrishnan,

R. and

permanent,

transitory

of reported

earnings.

sity).

Ramakrishnan,

R. and J.

the past: market value,

valuation

and sufficient

Journal

of Accounting,

J. Thomas,

19Yl. Valuation

of

and price-irrelevant

components

Working paper (Columbia

UniverThomas, 1992, What matters from

book value, or earnings? earnings

statistics for prior information,

Auditing

and

Finance.

7,

423%

464.

Rendleman.

R.J.. C.P. Jones and H.A. Latani,

lY87, Further insight into the standardized

unexpected

earnings

anomaly:

size and serial correlation

effects.

Financial

Review,

22,

131-144.

Salamon,

G. and E. Smith. lY77. Additional

evidence on

the time series properties

of reported

earnings per share:

Comment.

Journal of Finance, 32, 17YS-1801.

on analysts forecasts.

Schipper.

K.. IYYl, Commentary

Accounting

Horizons.

5, 105-121.

Shores,

D.. 1900. The association

between

interim

information

and security

returns

surrounding

earnings

announcements.

Journal

of Accounting

Research.

28,

164-181.

Shroff.

P.K.. lYY2. The variability

of earnings

and nonearnings

information,

Working paper (Ohio State University).

Siconolfi,

M.. lYY2. At Morgan

Stanley,

analysts

were

urged to soften harsh views. Wall Street Journal. 14 July

1902. Al and A6.

Sinha. P., L.D. Brown. and S. Das, 1993. Forecast

accuracy of individual

analysts

in nine industries:

a second

look.

Working

paper (State University

of New York.

Buffalo).

Stickel. S.E., I9Y0, Predicting

individual

analyst earnings

forecasts,

Journal of Accounting Research, 28, 409-317.

Stickel,

S.E..

19Yl. Common

stock returns

surrounding

earnings forecast revisions: more puzzling evidence.

Accounting

Review.

66. 402-416.

Stickel.

S.E.,

1992, Reputation

and performance

among

security analysts,

Journul of Finance, 47, 181 I-1836.

Stickel.

S.E..

1993, Accuracy

improvement

from a consensus of updated forecasts,

International Journal of Forecusting, 9, 345-353.

financial statement

measures

and analysts forecasts of earnings.

Journal of Accounting

and Economics.

IS. 347-372.

requirements

of security analysts, in: R. Abdel-khalik

and T. Keller (Editors),

Information

Requirements

of Security Analysts (Duke University Press. Durham,

NC).

Tversky,

A. and D. Kahneman.

1984, Judgment

under

uncertainty:

heuristic

and biases,

Science, 185. 11241131.

Varian.

H.R.,

1985. Divergence

of opinion

in complete

markets:

a note. Journal of Finance, 40, 309-317.

Verrecchia.

R.E., 1980, The rapidity of price adjustments

to

information.

Journal of Accounting

and Economics.

2.

63%Y2.

S.H.,

Accounting.

lYY2c. Return

Auditing

to fundamentals.

and Finance,

Journal

of

7, 465-483.

Philbrick,

D.R. and W.E. Ricks, 1991, Using Value Line

and IBES analyst forecasts in accounting

research,

Journcrl of Accounfing Research, 29, 397-417.

recognition

and the relevance

of earnings as an explanatory

variable

for returns.

Accounting Review, 67. X21-842.

Watts, R.L.,

1975, The time-series

behavior

of quarterly

earnings,

Working paper (University

of Newcastle).

Watts.

R.L..

terly

lY78.

EwwmicS.

Watts.

Systematic

earnings

and R.W.

annual

accounting

scurch,

15, 253-271,

role

Jourtml

of

Firwrlcitrl

6. 127-1.50.

R.L.

Wicdman.

abnormal

announcements,

C..

of

Lcftwich,

lYY3. Proxies

loss

lY77.

Journcrl

earnings.

The

for earnings

functions.

time scriea of

c!f Accounrirtg

Working

Kc>-

expectations:

paper

the

(Cornell

University).

Wiggins.

ings

J.B..

Working

Winkler.

contribute

paper

R.L.

forecasts.

1.57.

1000, Do

process

(Cornell

misrepresentations

to

drift?,

University).

and S. Makridakis.

Jorrrtd

post-announcement

of

150-

principal research interests are in the use of financial information by capital market

participants.

primarily security analysts. Dr. Brown has over

SO publications in the areas of accounting. finance and forecasting. and he has presented his research at over 35 universities. His research in the topical area of this paper has

been published in 71~~ Acwrrn~ing Revkrr~, Conremportw~

Accowttittg

Resctrrch. f~~tetxutiot~crl Journd

Op Fotwmrin~.

Jotrrmd of Accouttting Reseurch, Jourmrl of Ru.sincs.r

Foreusting.

Jowxul

c!f Fintrtwe, Journal

of f~orecusting. and

Jonrmrf of Portfolio

Matqemenr.

He is an Associate Editor

of the ft~frrmr~ionul Journul

of Forecusring

and Review o/

Qucrnrirtrrivr Fituncr cd Accounting;

he servcs on the editorial board of Conternftorury Accoudng

Rrxurch and is a

memhcr of the Exccutivc Committee of the Annual

cnce on Financial Economics and Accounting.

Confer-

## Гораздо больше, чем просто документы.

Откройте для себя все, что может предложить Scribd, включая книги и аудиокниги от крупных издательств.

Отменить можно в любой момент.