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The Association Between Financial Analysts’ Recommendation And Eps Forecast

Posted on:2014-06-07Degree:DoctorType:Dissertation
Country:ChinaCandidate:X F ZhangFull Text:PDF
GTID:1109330464461434Subject:Accounting
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Financial analysts play a key role in promoting effective operation of securities markets. Financial analysts collect information, including public information and non-public one obtained by visiting covered firms, process these information with their expertise and skills and disseminate these information to investors in form of analysts’ report. Financial analysts interpret previously disclosed information or discover information. These information will be transmitted to stock prices and thus market efficiency will be improved. Investors will be aware of some other details of the report as well as recommendations and EPS forecast, which are two essential complements of one analysts’ report. However, we know little about what the analyst do with the information to gain EPS forecast and recommendations, especially the valuations process from EPS forecast to recommendations. This paper investigates the association between analysts’recommendations and EPS forecast in perspective of PE model.Specifically, this paper examines the association between analysts’ recommendations and EPS forecast in three aspects. First, this paper investigates the relation between analysts’recommendations and EPS forecast. Valuation is the absolutely necessary step before analyst issue recommendations. Ohlson model and some other valuation theories demonstrate that EPS forecasts for future periods of a stock are the basic and indispensable information to determine the stock’s intrinsic value. And financial analysts’ EPS forecast is thought to be the best proxy of all the available EPS forecast (Beyer et al.,2010). In addition, PE model is the most frequently used valuation model by financial analysts. When it comes to employing the PE model, financial analysts and investors will take PE multiplier, EPS forecast and the current stock price combined into consideration to figure out the intrinsic value. And then they will compare the intrinsic value with the current price to judge whether the current price fully reflects all the public information. It will be interesting to study whether the intrinsic valuation of one stock based on PE model is consistent with analysts’ recommendations.Second, this paper also investigates what impact funds’ performance has on the relation between analysts’ recommendations and EPS forecast in terms of funds’ significantly owned stocks. Funds’ managers have strong incentives to indirectly bias analysts’recommendations since managers’ personal benefits are influenced by funds’ performance to some extent. Good funds’ performance both brings funds ’managers high compensation in current period and lays foundation for managers’ career development in future. Funds’ managers will try every means to pursue an excellent funds’ performance. As one of the most important information media, financial analysts will inevitably undertake funds ’managers’ pressure. Prior literature show that analysts’ recommendation optimism is positively related to funds’ performance rankings at the end of each year (Hong and Zhang, working paper). Will the funds’ performance affect analysts’ valuation process? This paper investigates this question empirically.Third, this paper investigates the probable reason that funds’ performance can affect the association between recommendations and EPS forecast. That is trading commissions. Trading commission fees account for more half of the annual revenue of almost each brokerage in China and fund companies are the quality clients to brokerage firms. Analysts’ report will be biased due to, first, brokerages’ arrangement of analysts’ compensation, second, that analysts’ report have to be issued under the name of brokerage other than analysts themselves. Fund companies’ decision to trade through which brokerage makes brokerages and brokerages’ analysts succumb to funds’ managers’ willingness and thus analysts are nicknamed as "Institutional Investors’ Analysts". Two papers have shown that affiliated analysts will issue favorable recommendations toward affiliated funds’ stock (Gu et al.,2013; Firth et al., 2013). If so, will non-affiliated analysts’ valuation be more objective? This paper hypothesize that trading commission probably is the channel through which client funds place pressure on analysts.Using the analysts’recommendation and EPS forecast of WIND database from January 1st,2007 to December 31st,2011 as the sample, this paper investigates the association between analysts’recommendations and EPS forecast in perspective of PE model. The main findings include the following ones.First, the higher the analysts’EPS forecast of the covered stock is, that is, the lower PE ratio based on PE model, the more likely the analysts are to issue favorable recommendations.Second, mutual funds’ stock holdings have a significantly negative impact on the use of analysts’ EPS forecast into recommendations. Compared to the funds’ non-significantly owned stocks, analysts’ recommendations of stocks significantly owned by funds depend less on EPS forecast. Mutual fund performance is an important incentive that funds’ managers exert pressure on analysts and affect analysts’ valuations procedures. Funds’ performance is closely related to funds’ managers’ compensations as well as career development. Financial analysts’ report is a significantly effective means for funds’ managers to pursue an excellent performance. And therefore, analysts’ valuation will be negatively affected by this conflict of interest. Under this circumstance, the EPS forecast is translated less into valuation process and recommendations consequently. The empirical findings are consistent with this hypothesis.Third, trading commission is the way in which fund managers’ have an influence on financial analysts. For the funds’significantly owned stocks, non-affiliated analysts’ recommendations rely more on EPS forecast than affiliated analysts’ recommendations. Affiliated analysts interpret no EPS forecast information into recommendations at all. It is an eventful task for brokerage to maintain friendly relationship with funds since trading commission constitutes the main part of brokerages’ revenue and funds’ are quality clients. This pressure will be transferred to individual analysts via individual analyst’s compensation mechanism. Both analysts’ recommendation and analysts’ valuation will be tainted by funds’ trading commission. The recommendation optimism from funds’ pressure documented by prior literature is just the result of analysts’ biased valuation and non-affiliated analysts’ valuation is more objective.This paper examines the relation between analysts’ recommendations and EPS forecast in perspective of PE model. The conclusions in this paper provide direct empirical evidence on how analyst put EPS forecast into recommendations and make contributions on the literature on analysts’ valuations. This paper contributes to the literature in three dimensions. First, this paper demonstrates that analysts interpret EPS forecast into recommendations via PE model and this finding provides empirical evidence on the view that EPS forecast is a key input variable to arrive at analysts’ recommendations. This also helps us understand what goes on inside analysts’ valuation black box. Second, the findings in this paper also show that analysts’ valuation will be biased downward due to the pressure from mutual funds. The recommendation optimism related to mutual funds noted by prior literature just reflects the final result of the valuation. Third, trading commission is the channel via which fund companies are able to impact analysts’ valuation. Both the industry evidence and the academic one indicate that trading commission will increase recommendations’ optimism. The empirical result in this paper presents a probable reseason for the mutual funds-related recommendations’ optimism (Gu et al,2013; Firth et al,2013). That is, the intrinsic value based on less EPS forecast lead to the recommendations’ optimism. For funds’ significantly owned stocks, analysts’ less translation of EPS forecast into recommendations results from affiliated analysts’ less translation of EPS forecast into recommendations than non-analysts’ translation.
Keywords/Search Tags:Financial Analysts, Stock Recommendations, EPS Forecast, Trading Commission
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