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Review of Accounting Studies

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01-09-2012

Information interpretation or information discovery: which role of analysts do investors value more?

Authors: Joshua Livnat, Yuan Zhang

Published in: Review of Accounting Studies | Issue 3/2012

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Abstract

This study provides evidence that a significant percentage of analyst forecast revisions are issued promptly after a broad set of corporate public disclosures and that investors perceive these prompt revisions as more valuable than nonprompt revisions. These results hold for all revisions, revisions outside of the earnings announcement window, or revisions in weeks preceding the earnings announcements and are also robust to various sensitivity tests. Investors particularly value analysts’ prompt interpretation of earnings announcements, Form 8-K filings, or certain qualitative news. To the extent that prompt revisions are more likely to reflect analysts’ information interpretation role, our results suggest that investors value more highly analysts’ ability to interpret public disclosures, especially less structured or non-financial disclosures, than their ability for information discovery.

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Both Francis et al. (2002) and Chen et al. (2010) focus on the association between market reactions to analyst revisions and those to earnings announcements, but they draw opposite conclusions. Chen et al. (2010) reconcile with Francis et al. (2002) by correcting the sample selection biases in Francis et al. (2002).

These forms are required filings with the Securities and Exchange Commission (SEC). Form 10-Ks are annual reports; Form 10-Qs are quarterly reports; Form 8-Ks are current reports to announce major events. In this paper, we generally refer to these forms as “10-K/10-Q filings” or “8-K filings.”

Our use of the promptness of analyst forecast revisions relative to corporate disclosures to infer the interpretation role follows prior research. Nevertheless, even if one does not accept this inference, our results that investors react significantly more strongly to prompt revisions than to nonprompt revisions are still important because they are different from prior literature due to our expanded definition of prompt revisions.

Even if, as pointed out by Mozes (2003), competition to revise forecasts quickly after public information releases comes at the cost of lower forecast accuracy, analysts may strategically manage these costs and benefits by releasing a forecast quickly in response to new information (Ramnath et al. 2008) and following up with a more thoroughly analyzed revision subsequently.

For example, material corporate events such as FDA approvals are likely to be filed in an 8-K form with the SEC in a timely fashion; a relatively large percentage of earnings guidance is issued concurrently with earnings announcements (e.g., Atiase et al. 2005).

This inference is also consistent with Kerl et al. (2012), who read more than 3,000 analyst reports for European firms from 2004 to 2006.

Among the 135 reports with PROMPT = 1, 120 refer to public news, and 15 do not. Among the 65 revisions with PROMPT = 0, 37 refer to public news, and 28 do not. The discrepancy could be attributable to several factors. First, our coding of promptness is based on only three types of firm-specific information events, while the reports may refer to any types of public news. Second, even when a report directly refers to some public news, it may not be prompt. In other words, it may reflect delayed information interpretation, as opposed to information discovery. In Sect. 4, we perform additional analyses to address these possibilities.

A small number of reports refer to multiple news items, in which case we focus on the first mentioned news item.

We use revisions after 1995 because SEC filings are broadly available in the SEC EDGAR database after 1995.

We focus on forecasts for annual earnings because of their greater availability. However, our inferences are unchanged if we analyze quarterly forecasts instead.

The portfolios are based on two size, three book-to-market, and three momentum portfolios.

To mitigate the effects by small scalers, we delete observations with stock price less than $1.

Using RREV allows us to mitigate the effects of extreme forecast revisions and also allows easier interpretation of regression coefficients as hedge returns. In additional tests, we replace RREV with the scaled forecast revisions SREV. Our inferences are unchanged. For example, in Model (1), the coefficient on SREV is 0.611, and the coefficient on SREV*PROMPT is 0.313; both are statistically significant.

The control variables that we include in the model largely follow Clement and Tse (2003). In additional robustness analyses, we also include the age of the forecasts (i.e., the (logged) number of days since the previous forecast) and its interaction with RREV in our model. Our inferences are unchanged.

Note this variable can be negative if the revision is issued after period-end but before the corresponding earnings announcements. In this case, we assign a value of 1 to the horizon variable.

For book-to-market ratios that have absolute values greater than 1, we assign a value of −1 or 1 to the observation to avoid undue influence by outliers.

We also check analyst coverage as an additional firm-specific variable. On average, our sample firms are covered by 17 analysts, and the median is about 11 analysts. We do not include analyst coverage as a control variable in our regressions because of its high correlation with firm size (the correlation coefficient is 0.68). In unreported analyses we add this as one additional control variable in our models and our inferences are unchanged.

As discussed above, the majority of 10-Q/10-K reports are accompanied by either an earnings announcement or an 8-K filing. To better gauge the relative market reactions to revisions promptly issued after 10-Q/10-K, we rerun our model with PROMPT = 0 and PRMOPT_10Q0 = 1 observations only. The coefficient on RREV*PROMPT_10Q0 remains significantly negative at −0.009, although with a much smaller magnitude. Overall, the results suggest that investors value analysts’ interpretation of 10-Q/10-K forms to a lesser extent than analysts’ information discovery or their interpretation of earnings announcements or 8-K filings.

Recall that as shown in Table 1, only 1.8 % of the sample revisions are issued within three trading days after 10-Q/10-K filings that are not clustered with other corporate disclosures.

Similar results are obtained when we exclude all prompt revisions after the earnings announcements (i.e., PROMPT_ER = 1) rather than just those on days 0 and 1.

Note that we use in this sub-section the revisions that occur in years 2002 onwards. Due to the new SEC requirements regarding Form 8-K disclosures, the number of Form 8-K filings has increased substantially after August 2004 (see Lerman and Livnat 2010). This may also contribute to the higher percentage of prompt revisions in this analysis.

We also examine the incremental effects of each of the five types of news. We find that investors place greater values on revisions after client announcements and buyback announcements than other types of announcements.

Another important aspect of analysts’ interpretation role is their ability to analyze whatever information they have, whether obtained through interpretation or through discovery, and transform it to a forecast for long-term growth. We thus focus on revisions when analysts also revise their long-term forecasts on the same date and regress excess returns on the revisions of the long-term forecasts, along with all independent variables in Model (1). We find a significantly positive coefficient on the long-term forecast revisions, suggesting that regardless of the sources of the information, investors value analysts’ ability to interpret the implications of information for long-term growth.

Thus we include prompt as well as nonprompt revisions that are at least 8 days after the public announcement.

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Title: Information interpretation or information discovery: which role of analysts do investors value more?
Authors: Joshua Livnat
Yuan Zhang
Publication date: 01-09-2012
Publisher: Springer US
Published in: Review of Accounting Studies / Issue 3/2012
Print ISSN: 1380-6653
Electronic ISSN: 1573-7136
DOI: https://doi.org/10.1007/s11142-012-9193-8

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