Analysts give more positive forecasts to potential future employers. Image courtesy of Shutterstock
Investors losing out to analysts' career aspirations
Investors are losing out to bias by banking analysts more concerned about career progression than accuracy of their forecasts, says new research by the University of Exeter and Harvard Business School.
Manipulation of markets has been a hot topic for several years, with new revelations appearing almost daily. Now it seems investors are also being misled by biased forecasts based on the likelihood of whether the companies involved may be a future employer. In addition, analysts who issue the most biased forecasts tend to move to better, higher paying and more prestigious jobs.
The research pinpoints the difference between the earnings forecasts given by analysts to companies which have a sell-side equity department and would therefore be potential future employers and those without. Specifically, analysts’ forecasts for these firms are more likely to exhibit ‘a walk down to beatable earnings’. This is a pattern where forecasts of annual earnings are optimistic early in the year but become less optimistic later in the year, and then just before the earnings announcement, they are at their most pessimistic. This allows company executives to beat their earnings forecasts, which frequently results in large positive changes in stock price. This pattern is not observed when banking analysts forecast earnings of companies not likely to be future employers.
Professor Joanne Horton from the University of Exeter commented: “Once again, it seems investors are paying the price whilst analysts and corporate executives are reaping the rewards of this behaviour, be it conscious or unconscious. This could explain the recent trend towards investors conducting their own analysis and relying more on the ‘wisdom of the crowds’ to inform their decision making. Compliance and governance officers should also take this seriously and perhaps re-consider reward structures.”
Date: 29 June 2015