A Theory of Analysts Forecast Bias

Posted: 31 Dec 1998

Abstract

In this paper, we provide an equilibrium explanation for the observed optimism in analysts' earnings forecasts. Our analysis provides theoretical support to the widely held notion that analysts engage in earnings optimism to gain access to management's private information. We show that a strategic analyst, who is motivated by improving the combined accuracy of his forecasts, issues a biased initial forecast to extract information from management, but issues unbiased forecasts subsequently. The management, on the other hand, provides more access because this optimistic bias reduces the proprietary costs associated with disclosure at the margin. An important element of our model is the assumption that analysts also have private information relevant to assessing firm value. Despite rational expectations about analyst bias, analysts' private information cannot be fully unravelled by other agents due to the noise introduced by the diversity in analysts' incentives.

JEL Classification: G14, M41

Suggested Citation

Krishnan, Murugappa (Murgie) and Sivaramakrishnan, Shiva, A Theory of Analysts Forecast Bias. Available at SSRN: https://ssrn.com/abstract=5308

Murugappa (Murgie) Krishnan (Contact Author)

Yeshiva University ( email )

500 West 185th Street
New York, NY 10033
United States

Shiva Sivaramakrishnan

Rice University ( email )

6100 South Main Street
Houston, TX 77005-1892
United States

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