On the Incentives for Financial Analysts to Make Optimistic Biased Forecasts
Manuel Larrán Jorge
In this paper we focus on forecasting the earnings per share of Spanish firms issued by financial analysts in Spain. We concentrate on earnings forecasting, not because the output is the most important, but because it is one of the most visible of activities or products generated by this professional group. The forecasting takes place in an environment that we characterise as being a mixture of agency and collaborative relationships with other market agents, in which the control and flow of information is crucial and where individuals are not necessarily assumed to be rational decision makers but are subject to errors and biases Our results are derived from three different studies: a large sample analysis of the accuracy and bias of earnings forecasts published by IRES; a survey of fifty-eight Spanish analysts; and interviews with eighteen Spanish analysts and fund managers. Although there could be difficulties in combining the results from such a spread of research methods, in our case, we believe the conclusions could be reinforced and the null hypothesis refuted. We find that the earnings forecasts are biased, inaccurate or inefficient at anything longer than short-term horizons, but that both analysts and fund managers are well aware of the biases and irrationalities inherent in the forecasting process. Our results are consistent with these shortcomings being largely driven by the analysts' need to stimulate trading and to protect their access to private information rather than failures in their ability to process data. It may be that forecasting is characterised by errors in human information processing, but if this is so we have little evidence that either the providers or users of earnings forecasts are aware of this-although of course they need not necessarily be so.
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