The Rise and Fall of Internet Stocks: Should Finanical Analysts Be Blamed?

Abstract

Using both the summary and detailed financial analysts earnings forecasts data from I/B/E/S, we study the role of financial analysts in the most recent Internet stock bubble. We examined the change of financial analysts' earnings forecasts around the Internet crash in April 2000. The empirical results suggest that financial analysts did indeed share some blame in the formation of the Internet stock bubble. Financial analysts as a whole were too optimistic about the Internet stocks before the market crash in April 2000. The rationality tests also suggest their earnings forecasts before the crash were less than rational. However, they revised down their earnings forecasts significantly after the burst of the bubble. We further documented that financial analysts whose employer was a lead underwriter for the Internet company (affiliated analysts) were actually more negative in their quarterly earnings forecasts relative to those of non-affiliated analysts. We interpret the latter evidence as supporting a conflict of interest hypothesis that affiliated analysts have incentive to accommodate managers' motive to underreport the earnings in order to have actual earnings "beat" the market expectations.

Keywords: Internet stocks, bubbles, finanical analysts, forecast bias, conflict of interests

JEL Classification: G10, G14, G24