Do financial analysts publish long-term forecasts in response to firms’ overinvestments?

ABSTRACT

This study examines the relationship between analysts issuing long-term earnings forecasts and firms overinvestment. This research demonstrates that a positive relationship exists between analysts issuing long-term forecasts and firms overinvesting. The relationship between analysts issuing a long-term forecast and firms overinvesting is more significant where asymmetry of information exists. Additionally, we find that a positive relation between overinvestments and long-term analyst forecast publications is more pronounced for firms covered by competent analysts. Finally, analysts benefit from promotion by issuing long-term forecasts in response to the firms’ overinvestment. These findings contribute to the related literature by confirming that investment decisions are considered important in analysts’ long-term earnings forecasts.

KEYWORDS:

• overinvestment
• financial analyst
• long-term earnings forecast

JEL CODES:

• G24
• G31
• M420

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1 Conversely, other prior literature (e.g., La Porta, 1996; Bradshaw, 2004; Barniv et al., 2009) demonstrates that long-term forecasts are biased, and negatively related to future excess returns; moreover, long-term forecasts revisions add little to forecasts revisions in explaining the annual returns variations (Liu & Thomas, 2000).

2 Owing to the nature of overinvestment, which arises under information asymmetry between managers and shareholders (investors), it is difficult to show directly how investors observe overinvestments, not just total investments, by firms, which is a limitation of our study.

3 Over (or under-) investment is not absolute, but relative to firms’ optimal level of investments. Therefore, more overinvestments can be interpreted as less underinvestments in our hypothesis. In other words, our hypothesis can also imply that analysts are less likely to issue long-term earnings forecasts in response to firms' underinvestments.

4 McNichols and Stubben (2008) suggested earnings management as one of the factors to explain why overinvestment occurs. To this end, they defined overinvestment and developed a mathematical model to capture overinvestment. We followed their study to define and measure the level of overinvestment.

5 Hubbard (1998) reviewed the literature on investment decisions in imperfect capital markets and explained that investment is correlated with investment opportunities and internal funds in imperfect capital markets. Moreover, he highlighted that investment greatly increases with internal funds for firms facing asymmetric information and incentive problems.

6 We eliminate observations where a promotion occurs in year t+2 following Jung et al. (2012) due to ambiguity related to the association with year t activity.

Additional information

Funding

This research did not receive any specific grant from funding agencies in the public, commercial, or not-for-profit sectors.