BEHAVIORAL RESEARCH IN ACCOUNTING American Accounting Association

Vol. 24, No. 2 DOI: 10.2308/bria-10283

2012
pp. 4764

The Effect of Positive and Negative Financial

and Nonfinancial Performance Measures on
Analysts Recommendations
Dipankar Ghosh
The University of Oklahoma
Anne Wu
National Chengchi University

ABSTRACT: This research experimentally examines the favorable/unfavorable

outcomes of a firms financial and nonfinancial performance measures on financial
analysts recommendation to divest or invest in a firm. The participants were financial
analysts who made recommendations ranging from definitely sell to hold to
definitely buy. The results show that financial and nonfinancial performance
measures and their favorableness have an interactive impact on analysts recommen-
dations. To be precise, the recommendations were very close to the definitely sell
anchor when the performance was unfavorable, irrespective of whether the measures
presented were financial or nonfinancial. Further, favorableness of performance on
nonfinancial measures appears to be irrelevant when performance on financial
measures is unfavorable. However, when performance on financial measures is
favorable, the effect of nonfinancial performance had a differential effect on analysts
recommendations depending on whether these measures indicated favorable or
unfavorable performance. Specifically, when nonfinancial performance was unfavor-
able, the recommendations were closer to hold on average, but the recommenda-
tions were closer to definitely buy on average when nonfinancial performance was
favorable. These results are consistent with our expectations. Overall, given that more
and more firms are disclosing nonfinancial measures along with the traditional financial
measures, and with an increasing number of firms reporting unfavorable financial
performance, the results of this research underline the importance of considering both
financial and nonfinancial measures and their outcomesfavorable and unfavorable
on analysts recommendations.
Keywords: rm performance; nancial and nonnancial measures; analysts.

Data Availability: Please contact the authors.

We thank the anonymous reviewers and the editor for their insightful comments. The authors gratefully acknowledge
financial support from National Science Council of Taiwan (NSC97-2410-H-004-072-MY3) and from National Natural
Science Foundation of China (No. 71032005).

Published Online: September 2012

47
48 Ghosh and Wu

INTRODUCTION

T
his research experimentally examines the favorableness of firms financial and nonfinancial
performance on analysts recommendation to divest or invest in a firm. Research shows
that the proportion of firms reporting losses has gradually increased (from , 1 percent in
1951 to about 36 percent by 2001; Klein and Marquardt 2006). Thus, analysts increasingly face
firms performing unfavorably. Separately, companies traditionally describe their performances
through the lens of financial measures (e.g., earnings per share, net income) which are criticized for
being short term oriented and disconnected with firms long term goals (Lev 2001; Ittner and
Larcker 2001). The Jenkins committee (AICPA 1994) concluded that the financial reporting model
is inadequate in meeting the informational needs of investors and that investors need more
information to assess the long term prospects of a firm via the disclosure of a firms key
nonfinancial measures; consequently, firms are periodically called to disclose more of their
nonfinancial measures (Bouwman et al. 2000; Lev 2001; Enhanced Business Reporting
Consortium 2005). In a 2009 national survey of CFOs and senior comptrollers conducted by
Grant Thornton LLP, 86 percent of the respondents believe that companies should supplement their
financial statements with nonfinancial measures. Anecdotal evidence suggests that many firms
already do so voluntarily (see Eccles et al. 2001; Upton 2001; Stanford 2011) since they realize the
value external stakeholders (e.g., analysts) place on nonfinancial measures because of their
long-term information content.1
Analysts refer to nonfinancial measures in their company reports (Previts et al. 1994) and pay
considerable attention to these measures in making their decisions (Breton and Taffler 2001;
Demsey et al. 1997; Low and Siesfield 1998). Nonfinancial measures are useful because they both
reflect and affect financial value (E&Y 1997, 5), help link managements actions to companys
financial results (Epstein and Palepu 1999) and future earnings estimates (Rajgopalan et al. 2003),
influence firms fundamental value (Amir and Lev 1996; Dhaliwal et al. 2010), and are positively
associated with analysts forecast accuracy (Orens and Lybaert 2007; Vanstraelen et al. 2003). Prior
research suggests that the value of the financial measures is increased by their interaction with
nonfinancial measures (Maines et al. 2002) and, more importantly, it is the nature of the firms
financial measures which determines the extent to which nonfinancial measures affect analysts
decisions. For example, analysts use of nonfinancial measures increases with a decrease in the
information content of earnings (e.g., from more noise because of firm leverage or stock returns
volatility; see Orens and Lybaert 2010) and positive or negative trends in financial measures affect
the level of attention analysts pay to nonfinancial measures (Coram et al. 2011). However, what is
unclear from prior research is how a firms financial and nonfinancial performance measures and the
degree to which they indicate favorable outcomes interact to affect analysts recommendation to
invest or divest in the firm. Thus, the research questions in the current study are worth examining
since analysts are often faced with both profitable and loss-making firms that use both financial and
nonfinancial measures to report organizational performance.
We examine our research question using an experiment. The participants were 104 financial
analysts. They made recommendation ratings concerning whether or not to invest in a firm for
different combinations of favorable and unfavorable financial and nonfinancial performance. The
ratings were provided on an 11-point scale ranging from definitely sell to hold to definitely
buy. The results indicate that the recommendations were very close to the anchor definitely sell
when both financial and nonfinancial performances were unfavorable. Further, this recommenda-
tion did not change materially so long as the financial performance was unfavorable; that is,

1
For example, California Public Employees Retirement System (CalPERS), the largest pension fund in the U.S.,
uses information on workplace practices of firms to screen potential investments.

Behavioral Research In Accounting

Volume 24, Number 2, 2012
Effect of Positive and Negative Financial and Nonfinancial Measures on Analysts Recommendations 49

favorableness of nonfinancial performance was irrelevant when financial performance was

unfavorable. However, when financial performance was favorable, nonfinancial measures had a
differential effect on analysts recommendations depending on whether these measures indicated
nonfinancial performance was favorable or unfavorable. Specifically, when nonfinancial
performance was unfavorable, on average, the recommendations were closer to hold, but they
were closer to definitely buy when nonfinancial performance was favorable.
Our results mirror those by other researchers. For example, Bouwman et al. (1987) find that
analysts use financial information primarily to screen for early rejection of unacceptable
investments while the subsequent decision to invest in a company appears to be based on
qualitative (nonfinancial) information. Garcia-Meca and Martinez (2007) find that analysts use
nonfinancial information more in the case of financially profitable firms than in the case of
financially unprofitable firms. In conclusion, the results of this study are consistent with our
expectations and underline the importance of considering the interaction of financial and
nonfinancial measures of firm performance along with the measures favorableness to understand
analysts recommendations.
The rest of the paper is as follows. The next section discusses the theory and the research
expectations. The third section discusses the research method, the fourth section presents the
results, and the last section contains concluding remarks.

THEORY AND HYPOTHESES

As stated earlier, prior research suggests that performance measuresfinancial and
nonfinancialand their favorableness may have an interactive effect on analysts decisions.
(Maines et al. 2002). Analysts are fixated on financial measures (Lipe 1998) perhaps because they
regard such measures to be more credible or reliable than nonfinancial measures. Financial
measures have a shorter time horizon compared to nonfinancial measures which are more long term
in nature (Banker et al. 2000; Kaplan and Norton 2001). Prior research suggests that the time
horizon of a firms performance measure affects the measures credibility because firms presumably
have better information about more immediate or short time horizon outcomes than long time
horizon outcomes. Thus, interim earnings forecasts should generally be perceived as more credible
than annual forecasts (Mercer 2005). Pownall et al. (1993) find support for this idea, showing that
interim management earnings forecasts generate larger stock price reactions than annual
management earnings forecasts, even after controlling for the amount of new information
contained in the forecast.
In comparison, the subjective nature of many of the nonfinancial measures may be curtailing
their usage. Hirst (1994) argues that users consider the degree of subjectivity inherent in a piece of
information when assessing the likelihood of whether the information is misreported or the
disclosure is credible. Evidence supports this argument. Hodge et al. (2006) experimentally show
that users perceive disclosures to be more credible in a mandated reporting environment, as in the
case of financial measures, because subjectivity levels are relatively low in such an environment
compared to the subjectivity levels in a discretionary reporting environment, as in the case of
nonfinancial measures.
Psychology research on attribution and persuasion suggests that the perceived credibility of
managements communications depends on users ex ante expectations of managements messages
and whether managements message confirms or disconfirms the expectation (Eagly and Chaiken
1975; Fiske and Pavelchak 1986). Thus, regarding performance measures favorableness, since
there is a tendency by management to provide a greater number of overly positive disclosures than
overly negative disclosures (McNichols 1989), unfavorable or negative outcomes are regarded as

Behavioral Research In Accounting

Volume 24, Number 2, 2012
50 Ghosh and Wu

more credible and have a greater impact than favorable or positive outcomes disclosure, ceteris
paribus (Mercer 2005).
The differential reaction to negative/positive outcomes is consistent with prospect theory which
suggests that investors are more sensitive to losses than gains (Kahneman and Tversky 1979) and in
making judgments, the negative aspects of an event or a message are weighted more heavily than
the positive aspects (Kahneman and Tversky 1984; Peeters and Czapinski 1990). Evidence from
archival research supports this claim. For example, disclosures of unfavorable news result in larger
analyst forecast revisions (Hassell et al. 1988; Williams 1996) and stock price reactions (Caimey
and Richardson 1999; Hutton et al. 2003) than disclosures of favorable news. Further, there are
marked differences in the accuracy and bias of analysts earnings forecast for loss making (i.e.,
unfavorable) firms than for non-loss (i.e., favorable) firms (Das 1998). That is, even professionals
react more to losses or negative information compared to gains or positive information (see
Anderson 1988).2
Accounting research shows that when a measure is favorable, supporting or additional
information increases the measures credibility. For example, favorable earnings forecasts are more
likely to result in stock price movements when the forecasts are accompanied by supporting
information such as sales forecasts and profit margins (Hutton et al. 2003; Gigler 1994; Caimey and
Richardson 1999). In contrast, unfavorable news forecasts result in stock price movements
regardless of whether they are accompanied by supporting information. Hutton et al. (2003) suggest
that a likely reason for the interaction of favorable forecasts and supporting information, but not for
unfavorable forecasts and supporting information is because unfavorable news is inherently more
credible to investors or analysts than favorable news. Hence, unfavorable news does not require
additional supporting information to increase its credibility.
The same argument may be extended to the interaction of financial/nonfinancial measures and
favorable/unfavorable outcomes. For example, when financial measures are unfavorable, their
impact on analysts decisions should be significant and invariant with the favorableness of
nonfinancial measures. However, if the financial measures are favorable, then nonfinancial
measures are like supporting information and should have a differential impact on analysts
recommendations depending on these measures favorableness. As discussed earlier, prior research
provides some evidence on the interactive effect of firms performance measures with the outcomes
of their favorableness on analysts decisions (Bouwman et al. 1987; Coram et al. 2011;
Garcia-Meca and Martinez 2007). The above discussion is the basis for the following hypotheses
and is depicted in Figure 1.
H1: Nonfinancial performance moderates the effect of financial measures on analysts
recommendation. Specifically:
H1a: When financial measures are unfavorable, nonfinancial measures have no effect on the
analysts investment rating of the firm.
H1b: When financial measures are favorable, analysts investment ratings of the firm are
higher when the nonfinancial measures are favorable compared to the investment ratings
when the nonfinancial measures are unfavorable.

2
Other studies in psychology evaluated the different cognitive processes observed when individuals respond to
unfavorable information. Skowronski and Carlston (1989) suggested that unfavorable information is perceived to
be more diagnostic; thus, individuals adopt a more negative bias in light of such information. Unfavorable events
prompt more cognitive analysis (Taylor 1991), narrowing the focus of attention on factors that cause the
unfavorable state (Broadbent 1971). Marketing research finds consumers are more sensitive to decreases in
perceived quality compared to increases in perceived quality (Anderson and Salisbury 2003).

Behavioral Research In Accounting

Volume 24, Number 2, 2012
Effect of Positive and Negative Financial and Nonfinancial Measures on Analysts Recommendations 51

FIGURE 1
Hypothesized Effect of the Interaction of Performance Measures and Their Favorableness on
Analysts Recommendation Ratings

RESEARCH METHOD
Design and Instrument Development
The experiment employed a 2 3 2 between-subjects design. The independent variables were
performance measures (financial and nonfinancial) and their favorableness (favorable/unfavorable).
Selecting the performance measures was done through several steps.
The initial set of nonfinancial measures, namely, management quality, innovation, product
quality, customer satisfaction, and employee satisfaction, were selected from a private companys
annual report. In the opinion of the companys management, these nonfinancial measures best
reflected the nature of the firms business and its long-term goals. These measures overlapped
significantly with the results of the Ernst & Young (1997) survey of analysts on which nonfinancial
measures they value most in share valuation and also ranked very high in the Dempsey et al. (1997)
survey of analysts on which measures they use to assess a firms strategic objectives. For
management quality and innovation, the company obtained the ratings from the most recent annual
survey of Americas Most Admired Companies (Fortune).3 Product quality was determined as a
ratio of the number of units returned as a percentage of total units sold. The company surveys its
customers every six months; the customer satisfaction score was the average of the overall
satisfaction score of the two most recent surveys. The firm also surveys all its employees once a
year; the employee satisfaction score is the average of all the questions posed to the employees in
the most recent years survey. For the experiment, the ratings or ratio numbers were selected to be
high or low so they would be perceived as favorable or unfavorable nonfinancial performance
measures (Appendix A briefly discusses the experimental instrument).
What constituted favorable and unfavorable financial measures were determined using
Altmans (1968) multivariate model (also see Foster 1986) to predict corporate bankruptcy.

3
The survey respondents of this survey are executives and directors in their own industry who give each company a
numerical score from 0 ( poor) to 10 (excellent).

Behavioral Research In Accounting

Volume 24, Number 2, 2012
52 Ghosh and Wu

Altmans model derives a Z-score using the following ratios (with different weights for each ratio):
Sales/Total Assets, Working Capital/Total Assets, Earnings before Interest and Taxes/Total Assets,
Retained Earnings/Total Assets, and Market Value of Equity/Book Value of Total Debt. A firm
with a Z-score below 1.81 (above 2.99) is considered to be a prime candidate for failure (not to fail)
(see Altman 1968). The models percentage-correct classification rate is 94 percent. To ensure the
appropriateness of using the ratios in Altmans model for this research, we examined the literature
on the ratios used by financial analysts. A common method of studying analysts use of financial
ratios is surveys wherein they are typically asked to indicate the significance of selected ratios when
making investment decisions or analyzing a firm. Subsequent to receiving the responses, the ratios
are classified into groups such as profitability, leverage, turnover, etc. While the specific ratios
selected differed among surveys, all the ratios in Altmans model were found to be significant in
surveys in which they were considered (Gibson 1987; Matsumoto et al. 1995; Dempsey et al.
1997). Thus, the ratios of Altmans model were used as performance measures and the Z-score was
used to delineate between favorable and unfavorable performances. For this research, two firms
were selected from the general industry machinery group (SIC code 3561) whose resultant Z values
indicated one of them likely to fail (i.e., unfavorable financial measures with Z , 1.81) and the
other not likely to fail (i.e., favorable financial measures with Z . 2.99). These two firms ratio
numbers were subsequently used in the experimental materials to identify unfavorable and
favorable financial performances.
The instrument was pilot tested on eight analysts from a financial institution (not a site for the
final experiment). For debriefing purposes, they were asked to assess the relevance of the financial
and nonfinancial measures used in the experimental materials for their investment recommenda-
tions. The Retained Earnings/Total Assets ratio was considered unimportant by all the analysts and
was dropped; the nonfinancial measure of product quality received the least support and was also
dropped. Thus, the final instrument (discussed below) had four financial and four nonfinancial
measures. To make absolute judgments, individuals typically use seven, plus or minus two cues
(Miller 1956); thus, our use of eight measures is consistent with prior research on information cues
and decision-making.

Participants and Procedure

The experimental materials were sent to five senior executives in five separate investment
companies (employing buy-side analysts). He (or she) distributed the materials to the analysts who
returned them directly to the researchers on completion. Each analyst did one task. Hence, they each
received experimental materials for one of the four combinations in our between-subjects design.
To avoid any biases, the firms name and industry affiliation was not disclosed. The order in
which the measures appeared in the instrument was randomized. The analysts were asked, As you
screen companies to make recommendations to your clients, how would you rate the above firm?
The analysts used an 11-point scale with 0 as Definitely Sell to 10 as Definitely Buy with 5
being labeled as Hold (see Appendix A).
Next, a number of questions were posed to the analysts both as manipulation checks as well as
to validate the assumptions made in developing the research hypotheses.

Manipulation Checks
Importance of the measures. The analysts assessed the importance of each of the eight (four
financial and nonfinancial) measures in their decisions on a seven-point scale (where 1 was Not
Important and 7 was Extremely Important). This was done to compare the importance of the
measures both within the financial and nonfinancial categorization and across these two groups of
measures.

Behavioral Research In Accounting

Volume 24, Number 2, 2012
Effect of Positive and Negative Financial and Nonfinancial Measures on Analysts Recommendations 53

Assessment of firm performance based on individual measures. Favorable/unfavorable

performance of both financial and nonfinancial measures for the firm were described quantitatively
without indicating any value proposition or providing any benchmark. To assess the analysts
perceptions of the favorableness of the measures, they were asked to evaluate the firms
performance based on individual financial and nonfinancial measures when they were favorable and
again when they were unfavorable. They rated the measures on a five-point scale categorized as
poor, fair, good, very good, or excellent.
Certain beliefs about the management of the firm. The questions were adopted from Mercer
(2005). The analysts were asked on a seven-point scale to assess the management on being
trustworthy, honest, and truthful (where 1 was Strongly Disagree and 7 was Strongly Agree).
The question on truthfulness was reverse coded for scoring purposes. These questions were asked to
assess if the characteristics of the measures used in this study influenced the analysts perception
about managements forthcomingness which prior research shows to affect investors decisions
(Mercer 2005).

Validity of Assumption Checks

Confidence. The analysts were asked about their confidence in their recommendation (on a 7-
point scale with 1 as Not at all Confident to 7 as Very Confident). We argued, based on prior
research, that financial (nonfinancial) measures being short-term (long-term) indicators of
performance are perceived to be more (less) credible or reliable. We also argued that managers
are more predisposed to reporting favorable firm performance; hence, unfavorable outcomes are
perceived to be more credible than favorable outcomes. This question served as a crosscheck of
these assertionsthe lesser the credibility of the measures, the lower will be the confidence in the
recommendation ratings.
Credibility of the measures to assess firm performance. We argued earlier that financial and
nonfinancial measures and firm performance outcomes (favorable and unfavorable) have different
credibility implications. Thus, the analysts were asked, on a seven-point scale, to assess
independently the credibility of financial and nonfinancial measures as well as favorable or
unfavorable outcomes of firm performance (1 was Not at all Credible; 7 was Very Credible).

DATA ANALYSES
Participants
In all, 116 financial analysts received the experimental materials, of which 104 completed and
returned the materials. The responses of the early and late responders (split based on the mid-point
of the days between the first and last respondent) were examined and were not found to be
significantly different from each other vis-a-vis the variables of interest in this study. The 12
analysts who did not participate in the study were spread over the five financial institutions. On
average, the participants were involved with analyzing companies for 7.01 years and were financial
analysts for 3.9 years. They were all buy-side analysts at the time they participated in this research.
Their average time horizon in most of their investment decisions is about 6.8 months. Of the 104
participants, 91 of them indicated they were very familiar with Fortune magazines annual survey
of Americas Most Admired Companies and the remaining 13 were quite familiar with the survey.

Descriptive Statistics
Table 1 pertains to the dependent variable, analysts recommendation ratings, and shows the
interaction effect of financial measures and nonfinancial measures and their favorableness on
analysts recommendation. When the measures are both unfavorable, they have the strongest effect
on analysts recommendation to sell; but when they are both favorable, the recommendations are

Behavioral Research In Accounting

Volume 24, Number 2, 2012
54 Ghosh and Wu

TABLE 1
Descriptive Statistics
Dependent VariableRecommendation Ratings

Scale: 0 or Definitely Sell, 5 or Hold, and 10 or Definitely Buy

more disposed toward buy. Also, the dependent variable was not affected by any of the non-
theoretical variables, namely, work experience, gender, or institutional affiliation.
The manipulation checks are shown in Table 2. As stated earlier, there were three manipulations
checks. The first was to ensure that the financial and nonfinancial measures were both equivalent in
terms of their importance to the analysts in their assessment of firm performance. The second
assessed the analysts favorableness of the measures since the firms were described quantitatively
without providing a benchmark. The third assessed if the characteristics of the measures used in this
study influenced analysts perceptions about managements forthcomingness. For importance of the
measures used in the experiment, all eight of them were rated close to being Extremely Important
on a seven-point scale (where 1 was Not Important and 7 was Extremely Important) (Table 2,
Panel A). For assessment of firm performance based on the individual measures, an overwhelming
majority of the analysts assessed both financial measures and nonfinancial measures as excellent
when their outcomes were favorable and poor when their outcomes were unfavorable (Table 2,
Panels B and C). The measures were rated on a scale categorized as poor, fair, good, very good, or
excellent. Finally, ratings of the analysts belief about the firms management on being trustworthy,
honest, and truthful (7-point scale with 1 as Strongly Disagree indicating low beliefs about the
above factors to 7 as Strongly Agree to indicate high beliefs), ranged from 5.7 to 6.2 (Table 2,
Panel D) and were not statistically different from each other.

Hypotheses Testing
The overall hypothesis is that nonfinancial measures will moderate the effect of financial
measures on analysts recommendation. Further, when financial measures are unfavorable,
nonfinancial measures will have no effect on the analysts investment rating of the firm. However,
when financial measures are favorable, analysts investment ratings of the firm will be higher when
the nonfinancial measures are favorable compared to the investment ratings when the nonfinancial
measures are unfavorable.

Behavioral Research In Accounting

Volume 24, Number 2, 2012
Effect of Positive and Negative Financial and Nonfinancial Measures on Analysts Recommendations 55

TABLE 2
Manipulation Checks

Panel A: Importance of the Measures

Mean S.D.
Financial
a. Sales/Total assets 5.62 0.67
b. Working capital/Total assets 5.59 0.43
c. Earnings before interest and taxes/Total assets 6.02 0.24
d. Market value of equity/Book value of total debt 5.46 0.36
Nonfinancial
a. Management quality 6.26 0.52
b. Innovation 6.02 0.32
c. Customer satisfaction 5.86 0.44
d. Employee satisfaction 5.68 0.69

Scale: 0 is Not Important; 7 is Extremely Important

Panel B: Evaluation of Firm Performance Based On Individual Financial Measure

Very Good Excellent Fair Poor
When Favorable
a. Sales/Total assets 1.9% 98.1%
(2/104) (102/104)
b. Working capital/Total assets 3.8% 96.2%
(4/104) (100/104)
c. Earnings before interest and taxes/Total assets 4.8% 95.2%
(5/104) (99/104)
d. Market value of equity/Book value of total debt 1.9% 98.1%
(2/104) (102/104)
When Unfavorable
a. Sales/Total assets 1.0% 99.0%
(1/104) (103/104
b. Working capital/Total assets 2.9% 97.1%
(3/104) (101/104)
c. Earnings before interest and taxes/Total assets 1.9% 98.1%
(2/104) (102/104)
d. Market value of equity/Book value of total debt 3.8% 96.2%
(4/104) (100/104)

Scale: Poor, Fair, Good, Very Good, Excellent

Panel C: Evaluation of Firm Performance Based on Individual Nonfinancial Measure

Very Good Excellent Fair Poor
When Favorable
a. Management quality 2.9% 97.1%
(3/104) (101/104)
b. Product quality 1.9% 98.1%
(6/104) (102/104)
c. Innovativeness 4.8% 95.2%
(5/104) (99/104)
(continued on next page)

Behavioral Research In Accounting

Volume 24, Number 2, 2012
56 Ghosh and Wu

TABLE 2 (continued)
Very Good Excellent Fair Poor
d. Ability to attract and retain talented people 1.9% 98.1%
(3/104) (102/104)
When Unfavorable
a. Management quality 0.0% 100%
(0/104) (104/104)
b. Product quality 1.0% 99.0%
(4/104) (103/104)
c. Innovativeness 3.8% 96.2%
(4/104) (100/104)
d. Ability to attract and retain talented people 2.9% 97.1%
(3/104) (101/104)
Scale: Poor, Fair, Good, Very Good, Excellent

Panel D: Beliefs about the Firms Management on being Trustworthy, Honest, and Truthful

Summary of three questions: Seven-point scale with 1 as Strongly Disagree to indicate low beliefs about the above
factors to 7 as Strongly Agree to indicate high beliefs.

First, the overall hypothesis was tested using an ANOVA model for financial and nonfinancial
measures. The results (Table 3, Panel A) show the overall model is significant (F 194.80; p
0.0001; R2 0.8539). An examination of the source variables show that while both financial and
nonfinancial measures were significant, their interaction was also significant at (p 0.0001),
suggesting that the analysts recommendation rating differed depending on the levels of the
independent variables.
To better understand the above interaction, we followed up the analysis with two planned
comparisons. The first comparison pertains to H1a; that is, when financial measures are unfavorable,
nonfinancial measures have no effect on the analysts investment ratings of the firm. The results
(Table 3, Panel B) show the overall ANOVA model is insignificant (F 1.53; p 0.2227; R2
0.302). A follow-up t-test (Table 3, Panel C) shows that the mean analysts recommendation rating
of 1.87 when financial measures were unfavorable but nonfinancial were favorable was not
significantly different from the rating of 1.58 when both financial and nonfinancial were unfavorable
(t 1.23; p 0.2286). These results are consistent with the expectations of H1a.
The second planned comparison pertained to H1b; that is, when financial measures are
favorable, analysts investment ratings of the firm will be higher when the nonfinancial measures are

Behavioral Research In Accounting

Volume 24, Number 2, 2012
Effect of Positive and Negative Financial and Nonfinancial Measures on Analysts Recommendations 57

TABLE 3
Effect of the Interaction of Measures and Favorableness on Analysts Recommendations
Ratings (RATE)

Panel A: Overall Effect of the Measures and Their Favorableness (ANOVA, n 104)
Source of Variation df SS MS F-value p
Interaction
Financial 3 Nonfinancial 1 95.74 95.74 102.70 0.0001
Main Effects
Financial (fav./unfav.) 1 311.59 311.59 334.26 0.0001
Nonfinancial (fav./unfav.) 1 137.45 137.45 147.45 0.0001
Model 3 544.77 181.59 194.80 0.0001

Panel B: Planned Contrast: Financial Measures are Unfavorable (ANOVA, n 51)

Source of Variation df SS MS F-value p
Contrast
Nonfinancial favorable versus Nonfinancial unfavorable 1 1.50 1.50 1.53 0.2227

Panel C: t-test (Financial Measures are Unfavorable)

Variable n Mean t (Cochran) p
Nonfinancial Unfavorable 26 1.58 1.23 0.2286
Nonfinancial Favorable 25 1.87

Panel D: Planned Contrast: Financial Measures are Favorable (ANOVA, n 53)

Source of Variation df SS MS F-value p
Contrast
Nonfinancial favorable versus Nonfinancial 3 unfavorable 1 231.69 231.69 262.39 0.0001

Panel E: t-test (Financial Measures are Favorable)

Variable n Mean t (Cochran) p
Nonfinancial Unfavorable 26 4.42 16.09 0.0001
Nonfinancial Favorable 25 7.26

favorable compared to the investment ratings when the nonfinancial measures are unfavorable. The
results (Table 3, Panel D) show the overall ANOVA model is significant (F 262.39; p 0.0001; R2
0.8373). A follow-up t-test (Table 3, Panel E) shows that the mean analysts recommendation
rating of 7.26 when both financial and nonfinancial measures were favorable is significantly higher
than the rating of 4.42 when financial measures were favorable but nonfinancial measures were
unfavorable (t 16.09; p 0.0001). These results are also consistent with the expectations of H1b.

Additional Analyses
These were done to validate the assumptions made about financial and nonfinancial measures
in developing research hypotheses. For confidence in recommendation ratings (Table 4, Panel A),

Behavioral Research In Accounting

Volume 24, Number 2, 2012
58 Ghosh and Wu

TABLE 4
Additional Analyses
Panel A: Confidence in Recommendation Ratings

On a seven-point scale with 1 as Not at all Confident to 7 as Very Confident

Panel B: Credibility of the Measures of Firm Performance

Mean S.D.
Financial Measures 6.15 0.66
Nonfinancial Measures 5.38 0.61
Favorable Outcomes 5.85 0.62
Unfavorable Outcomes 6.48 0.58
Descriptive Statistics Scale: 0 is Not at all Credible; 7 is Extremely Credible

Panel C: t-tests
Variable n Mean Std. Err. t-value p
Difference: Fin. versus Nonfinancial 104 0.77 0.09 5.11 0.001
Difference: Unfav. versus Favorable 104 0.63 0.08 4.53 0.001

the analysts seem to be more confident when measures are financial and the outcomes are
unfavorable. Clearly they are least confident when both financial and nonfinancial measures are
favorable (mean 3.93) and the most confident when both measures are unfavorable (mean 6.71).
And, for credibility of the measures of firm performance, on an average (Table 4, Panels B and C),
analysts rated the overall credibility of the financial measures at 6.15 and nonfinancial measures at
5.38; further, these ratings were significantly different from each other (t 5.11; p 0.001). Also,
the credibility ratings was 6.48 for unfavorable outcomes and 5.85 for favorable outcomes; these
ratings were also significantly different from each other (t 4.53; p 0.001).

DISCUSSION
This research experimentally examines the favorableness of firms financial performance
measures and nonfinancial performance measures on analysts recommendation to divest or invest
in a firm. In general, prior research suggests that financial measures and unfavorable outcomes are
regarded as more credible (Mercer 2004, 2005). Although there is some research on disclosure

Behavioral Research In Accounting

Volume 24, Number 2, 2012
Effect of Positive and Negative Financial and Nonfinancial Measures on Analysts Recommendations 59

credibility, the focus of that research is with reference to the management (i.e., the messenger or
source bias)their reporting incentives, reputation and forthcomingnessbut not the nature or
characteristics of the firms performance measures (i.e., the message). Credibility is an important
component of information usefulness (Hutton et al. 2003; Williams 1996), the primary criterion for
accounting information in the FASBs Statement of Financial Accounting No. 1.
A total of 104 buy-side analysts participated in this research.4 Manipulation checks show that
overall credibility ratings of unfavorable and financial measures were significantly greater than the
overall ratings of favorable and nonfinancial measures. As hypothesized in H1, we first examined
the overall interactive effects of financial and nonfinancial measures and their favorableness on
analysts recommendation decisions. Since the interactive effect was significant, we examined first
the analysts recommendation for favorable and unfavorable nonfinancial measures holding
financial measures favorable (H1a) and then for favorable and unfavorable nonfinancial measures
holding financial measures unfavorable (H1b). As hypothesized, the results indicate that the
recommendations were almost definitely sell when both financial and nonfinancial measures
were unfavorable. Further, this recommendation did not change materially so long as the financial
measures were unfavorable; that is, favorableness of nonfinancial measures was irrelevant when
financial measures are unfavorable, consistent with the expectations of H1a. However, when the
financial measures were favorable, nonfinancial measures had a differential effect on analysts
recommendations depending on whether these measures were favorable or unfavorable.
Specifically, when nonfinancial measures were unfavorable, on an average, the recommendations
were closer to hold, but were closer to definitely buy when nonfinancial measures were
favorable. This is consistent with H1b. Our results mirror those of other researchers.
The current research makes at least two contributions to the performance measures literature.
First, as far as we know, this is the first research which systematically examines the influence of
financial and nonfinancial measures of firm performance and their favorableness on analysts
recommendations. Prior research on credibility was with reference to the management (i.e., the
source bias or the messenger) but not characteristics of the performance measures (i.e., the
message). Second, we provide evidence of the informativeness of nonfinancial measures in capital
market assessment of firms and financial analysts recommendations, though their effect is bounded
by the favorableness of financial measures. In other words, the results give credence to the
arguments for greater external communication of nonfinancial information.
Our experiment is subject to the typical limitations of any experimental study. We
acknowledge that analysts often deal with more firm-specific and industry-specific information
when making investment recommendations which we did not provide. Our findings are also
parameterized by design features, such as the specific measures used, and that the favorableness of
the measures was aggregated (i.e., the measures were either all favorable or all unfavorable).
Perhaps other specific nonfinancial measures, especially industry-specific nonfinancial measures,
may affect firm valuation differently than the measures used in this study.
A strong focus by analysts on financial data does not provide an accurate earnings forecast
(Opdyke 2000). Meanwhile, as discussed earlier, several studies show the relevance and importance
of nonfinancial measures to analysts. Nevertheless, nonfinancial measures are hard to mandate and

4
The main difference between buy-side and sell-side analysts is the type of firm that employs them and the people
to whom they make recommendations. A sell-side analyst works for a brokerage firm and makes
recommendations to the clients of the firm. A buy-side analyst usually works for a pension fund or mutual
fund company. These individuals perform research and make recommendations to the money managers of the
fund that employs them. Though the participants in the current research were all buy-side analysts, the results are
unlikely to be materially different if the participants were sell-side analysts since the basic decision they both
make is similarrecommend whether to invest or divest in a firm.

Behavioral Research In Accounting

Volume 24, Number 2, 2012
60 Ghosh and Wu

to standardize because of the firm- and industry-specific nature of such measures, the disclosure
costs (e.g., competitive costs) and the risk of receiving vague and uninformative disclosure (Skinner
2008). Further, voluntary disclosure of nonfinancial information is found to be more effective in
improving the efficient functioning of capital markets than mandated nonfinancial disclosure
(Skinner 2008). Thus, a better understanding of the circumstances when nonfinancial information
are (1) used more by analysts, and (2) significantly impact analysts decisions may increase
voluntary disclosure of nonfinancial measures by firms. For example, Orens and Lybaert (2010)
show that financial analysts use more nonfinancial information when the financial measures are
noisy. Our research, as far as we know, is the first one which systematically examines the influence
of financial and nonfinancial measures of firm performance and their favorableness on analysts
recommendations to divest or invest in a firm. While it highlights the importance of nonfinancial
measures to analysts when firms are doing well financially, giving credence to the argument for
greater disclosure of nonfinancial information by firms, what about when firms are not doing well
financially? Future research can focus on what can be done so that analysts are less fixated by
financial measures. For example, are certain nonfinancial measures (e.g., management quality) or
categories of nonfinancial measures more valuable than others (e.g., the different perspectives in
Balanced Scorecard)? Or, if the reliability of the nonfinancial measures is increased by having them
audited, will their usage and influence increase (see Libby et al. 2002).5
Additional future research entails capturing different dimensions of firms exogenous and
endogenous variables which affect the use of nonfinancial measures, such as strategy of the firm,
industry characteristics (i.e., high or low tech), growth opportunities, ownership characteristics, etc.,
and examine how they affect the decisions of financial analysts. Using the proxy text files of Lexis/
Nexis, it is possible to identify the use of nonfinancial measures by firms (see Ittner and Larcker
1998) and it is possible that the information content of these measures is already impacted in
analysts recommendations. Future research, thus, can examine nonfinancial measures which are
publicly available with those measures shown to be important via survey and assess the incremental
contribution of either group of nonfinancial measures on analysts recommendations.

REFERENCES
American Institute of Certified Public Accountants (AICPA). 1994. Accounting Standards Executive
Committee. Disclosure of Certain Significant Risks and Uncertainties. Statement of Position No. 94-
6. New York, NY: AICPA.
Amir, E. and B. Lev. 1996. Value-relevance of non-financial information: The wireless communication
industry. Journal of Accounting and Economics 22 (1/3): 330.
Anderson, E. W. 1988. Transaction costs as determinants of opportunism in integrated and independent
sales forces. Journal of Economic Behavior and Organization 9 (3): 247264.
Anderson, E. W., and L. C. Salisbury. 2003. The formation of market-level expectations and its covariates.
Journal of Consumer Research 30 (1): 115124.
Altman, E. I. 1968. Financial ratios, discriminant analysis, and the prediction of corporate bankruptcy.
Journal of Finance 23 (4): 589609.
Banker, R., G. Potter, and D. Srinivasan. 2000. An empirical investigation of an incentive plan that included
nonfinancial measures. The Accounting Review 75 (1): 6592.
Bouwman, M. L., P. A. Frishkoff, and P. Frishkoff. 1987. How do financial analysts make decisions? A process
model of the investment screening division. Accounting, Organizations and Society 12 (1): 129.

5
Libby et al. (2002) show that audit report increases the degree to which managers rely on nonfinancial measures.
Presumably, the audit function enhanced the measures credibility.

Behavioral Research In Accounting

Volume 24, Number 2, 2012
Effect of Positive and Negative Financial and Nonfinancial Measures on Analysts Recommendations 61

Breton, G., and R. J. Taffler. 2001. Accounting information and analyst stock recommendation decisions: A
content analysis approach. Accounting and Business Research 31 (2): 91101.
Broadbent, D. E. 1971. Decision and Stress. London, U.K.: Academic Press.
Caimey, T., and F. Richardson. 1999. The Credibility of Management Forecasts of Annual Earnings.
Working paper, Florida Atlantic University.
Coram, P. J., T. J. Mock, and G. S. Monroe. 2011. Financial analysts evaluation of enhanced disclosure of
non-financial performance indicators. The British Accounting Review 43: 87101.
Das, S. 1998. Financial analysts earnings forecasts for loss firms. Managerial Finance 24 (6): 3950.
Dempsey, S. J., J. F. Gatti, D. J. Grinell, and W. L. Cats-Baril. 1997. The use of strategic performance
variables as leading indicators in financial analysts forecasts. The Journal of Financial Statement
Analysis 2 (4): 6179.
Dhaliwal, D. S., O. Z. Li, A. Tsang, and Y. G. Yang. 2010. Voluntary Nonfinancial Disclosure and the
Cost of Equity Capital: The Initiation of Corporate Social Responsibility Reporting. Working
paper, The University of Arizona. Available at: http://papers.ssrn.com/sol3/papers.
cfm?abstract_id1687155
Eagly, A. H., and S. Chaiken. 1975. An attribution analysis of the effect of communicator characteristics on
opinion change: The case of communicator attractiveness. Journal of Personality and Social
Psychology (July): 136144.
Eccles, R., R. Herz, E. Keegan, and D. M. H. Phillips. 2001. The Value Reporting Revolution. New York,
NY: John Wiley and Sons.
Enhanced Business Reporting Consortium (EBRC). 2005. The Enhanced Business Reporting
Framework. Available at: http://www.ebr360.org/downloads/ebr.framework.publicexposure.2005.
10.pdf
Epstein, M. J., and K. J. Palepu. 1999. What financial analysts want. Strategic Finance 80 (10): 4852.
Ernst & Young LLP. 1997. Measures That Matter. New York, NY: E&Y LLP.
Fiske, S., and M. Pavelchak. 1986. Category-based versus piecemeal-based affective responses:
Developments in schema-triggered effect. In Handbook of Motivation and Cognition, edited by
Sorrentino, R., and E. Higgins 167203. New York, NY: Guilford Press.
Foster, G. 1986. Financial Statement Analysis. Englewood Cliffs, NJ: Prentice Hall.
Garcia-Meca, E., and I. Martinez. 2007. The use of intellectual capital information in investment decisions:
An empirical study using analyst reports. The International Journal of Accounting 42 (1): 5781.
Gibson, C. 1987. How chartered financial analysts view financial ratios. Financial Analysts Journal (May-
June): 7476.
Gigler, F. 1994. Self-enforcing voluntary disclosures. Journal of Accounting Research 32 (2): 224240.
Hassell, J., R. Jennings, and D. Lasser. 1988. Management earnings forecasts: Their usefulness as a
source of firm-specific information to security analysts. Journal of Financial Research 11 (4): 303
319.
Hirst, D. 1994. Auditors sensitivity to source reliability. Journal of Accounting Research (Spring): 113
126.
Hodge, F., P. Hopkins, and J. Pratt. 2006. The credibility of classifying hybrid securities as liabilities or
equity. Accounting Organizations and Society (October): 623634.
Hutton, A., G. Miller, and D. Skinner. 2003. The role of supplementary statements with management
earnings forecasts. Journal of Accounting Research 41: 867890.
Ittner, C. D., and D. Larcker. 1998. Innovations in performance measurement: Trends and research
implications. Journal of Management Accounting Research 10: 205238.
Ittner, C. D., and D. F. Larcker. 2001. Assessing empirical research in managerial accounting: A value
based management perspective. Journal of Accounting and Economics 32: 349410.
Kahneman, D., and A. Tversky. 1979. Prospect theory: An analysis of decision under risk. Econometrica
47: 263292.
Kahneman, D., and A. Tversky. 1984. Choices, values, and frames. American Psychologist 39: 341350.
Kaplan, R. S., and D. P. Norton. 2001. The Strategy-Focused Organization. Boston, MA: Harvard Business
School Press.

Behavioral Research In Accounting

Volume 24, Number 2, 2012
62 Ghosh and Wu

Klein, A., and C. A. Marquardt. 2006. Fundamentals of accounting losses. The Accounting Review 81 (1):
179206.
Lev, B. 2001. Intangibles: Management, Measurement, and Reporting. Washington, D.C.: Brookings
Institute Press.
Libby, T., S. Salterio, and A. Webb. 2002. The balanced scorecard: The effects of assurance and process
accountability on managerial judgment. The Accounting Review 79 (4): 10751094.
Lipe, M. G. 1998. Individual investors risk judgments and investment decisions: The impact of accounting
and market data. Accounting, Organizations and Society 23 (7): 625640.
Low, J., and T. Siesfield. 1998. Measures that matter. Strategy and Leadership (March/April): 2438.
Maines, L., E. Bartov, P. M. Fairfield, and E. Hirst. 2002. Recommendations on disclosure of nonfinancial
performance measures. Accounting Horizons (December): 353362.
Matsumoto, K., M. Shivaswamy, and J. P. Hoban, Jr. 1995. Security analysts view of the financial ratios of
manufacturers and retailers. Financial Practice and Education (Fall/Winter): 4455.
McNichols, M. 1989. Evidence of informational asymmetries from management earnings forecasts and
stock returns. The Accounting Review 64 (1): 127.
Mercer, M. 2004. How do investors assess the credibility of managements disclosures? Accounting
Horizons 18 (3): 185196.
Mercer, M. 2005. The fleeting effects of disclosure forthcomingness on managements reporting credibility.
The Accounting Review 80 (2): 723744.
Miller, G. A. 1956. The magical number seven, plus or minus two: Some limits on our capacity for
processing information. The Psychological Review 63 (2): 8197.
Opdyke, J. 2000. Best on the Street 2000 Analysts Survey: The winningest pros of them all. Wall Street
Journal (July 25): 13.
Orens R., and N. Lybaert. 2007. Does the financial analysts usage of nonfinancial information influence the
analysts forecast accuracy? Some evidence from the Belgian sell-side financial analysts.
International Journal of Accounting 42 (3): 237271.
Orens R., and N. Lybaert. 2010. Determinants of sell-side financial analysts use of non-financial
information. Accounting and Business Research 40 (10): 3953.
Peeters, G., and J. Czapinski. 1990. Positive-negative asymmetry in evaluations: The distinction between
affective and informational negativity effects. In European Review of Social Psychology, edited by
Stroebe, W., and M. Hewstone (1, 3360). Chichester, U.K.: Wiley.
Pownall, G., C. Wasley, and G. Waymire. 1993. The stock price effects of alternative types of management
earnings forecasts. The Accounting Review 68 (4): 896912.
Previts, G. J., R. J. Bricker, T. R. Robinson, and S. J. Young. 1994. The content analysis of sell-side
financial analyst company reports. Accounting Horizons 8 (2): 5570.
Rajgopal, S., T. Shevlin, and M. Venkatachalam. 2003. Does the stock market fully appreciate the
implications of leading indicators for future earnings? Evidence from order backlog. Review of
Accounting Studies 8 (4): 461492.
Skinner, D.J. 2008. Accounting for intangiblesa critical review of policy recommendations. Accounting
and Business Research 38 (3): 191204.
Skowronski, J. J., and D. E. Carlston. 1989. Negativity and extremity biases in impression formation: A
review of explanations. Psychological Bulletin 105: 131142.
Standford, D. 2011. Why sustainability is winning over CEOs. BusinessWeek (March 31).
Taylor, S. E. 1991. Asymmetrical effects of positive and negative events: The mobilization-minimization
hypothesis. Psychological Bulletin 110: 6785.
Upton, W. S. Jr. 2001. Special Report: Business and Financial Reporting, Challenges From the New
Economy. Norwalk, CT: FASB.
Vanstraelen, A., M. Zarzeski, and S. Robb. 2003. Corporate nonfinancial disclosure practices and financial
analyst behavior across three European countries. Journal of International Financial Management
and Accounting 14 (3): 249278.
Williams, P. 1996. The relation between a prior earnings forecast by management and analysts response to
a current management forecast. The Accounting Review 71 (1): 103113.

Behavioral Research In Accounting

Volume 24, Number 2, 2012
Effect of Positive and Negative Financial and Nonfinancial Measures on Analysts Recommendations 63

APPENDIX A
EXPERIMENTAL INSTRUMENT
Please evaluate the firm below based only on the information provided. You are given selected
financial and nonfinancial information about a firm. The information is purposely limited, but
please use any of the eight measures you want. All the eight measures are from the most recently
available annual report of the firm. The four financial ratios are commonly used in the evaluation of
a firms financial health. The four nonfinancial measures are determined by the management since,
in their opinion, the measures best reflect the firms nature of the business. How the nonfinancial
measures are determined is briefly discussed next:

Management Quality: This is obtained from the most recent annual survey of Americas
Most Admired Companies (Fortune). The survey respondents are
executives and directors in their own industry who give each
company a numerical score from 0 (poor) to 10 (excellent).
Innovation: This is also obtained from the most recent annual survey of
Americas Most Admired Companies.
Customer Satisfaction: The firm surveys its customers every six months (please see page
__ for the survey questions). In general, a score of 5 is most
desired and a score of 1 is least desired. The score below is the
average of the overall score of the two surveys from the most recent
year.
Employee Satisfaction: The firm surveys all its employees once a year (please see page __
for the survey questions). In general, a score of 5 is most desired
and a score of 1is least desired. The score below is the average of
all the questions posed to the employees.

Experimental Manipulations
A. Interaction Effect: Unfavorable Financial Measures and Unfavorable Nonfinancial
Performance Measures:

B. Interaction Effect: Favorable Financial Measures and Favorable Nonfinancial Performance

Measures

Behavioral Research In Accounting

Volume 24, Number 2, 2012
64 Ghosh and Wu

C. Interaction Effect: Favorable Financial Measures and Unfavorable Nonfinancial Measures

(B1 and A2), or Unfavorable Financial Measures and Favorable Nonfinancial Measures
(A1 and B2)
The analysts received one of the versions of (A), (B), or (C).
The following question was posed to the analysts:
1. As you screen firms to make recommendations to your clients, how would you rate the
above firm?

Behavioral Research In Accounting

Volume 24, Number 2, 2012
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.