Why Don’t Analysts Use Their Earnings Forecasts in Generating Stock Recommendations?

Abstract

While a large literature has examined analysts’ earnings forecasts or stock recommendations in isolation, there is little research on the effectiveness with which analysts translate their earnings forecasts into recommendations (referred to as translational effectiveness). This study provides a comprehensive analysis of the determinants of analysts’ translational effectiveness, including the investment banking pressure considered in prior research and four new factors (i.e., insider trading, trading commissions, institutional ownership and investor sentiment). Consistent with prior research, the influence of investment banking on translational effectiveness is reduced in the period subsequent to the 2002/2003 regulatory changes. However, the effect of insider trading, institutional ownership and investor sentiment on translational effectiveness remains as significant or becomes even stronger. In addition, the combined influence of these four new factors on translational effectiveness is as equally important as the influence of the investment banking pressure.

Keywords: analysts, recommendation, earnings forecast

JEL Classification: G14; M41