Coexistence and Dynamics of Overconfidence and Strategic Incentives

Abstract:     
We present a two-stage model for the decision making process of financial analysts when issuing earnings forecasts. In the first stage, financial analysts perform a fundamental analysis in which they are prone to a behavioral bias. In the second stage analysts can distort their earnings forecasts in line with their strategic incentives. The paper analyzes this decision process throughout the forecasting period and explains the underlying drivers. Using quarterly earnings forecasts, we document that financial analysts overweight their private information throughout the entire forecasting period. At the same time, financial analysts behave strategically. They issue initial optimistic forecasts by strategically inflating their forecast. In their last revision, they become pessimistic and strategically deflate their earnings forecast, which creates the possibility of a positive earnings surprise. This analysis of the dynamics of the decision process provides empirical evidence on the coexistence of overconfidence and strategic incentives.

Number of Pages in PDF File: 40

Keywords: Financial analysts, Earnings Forecasts, Overconfidence, Conflicts

JEL Classification: G14, G17, G24

working papers series