The Effect of Experience on Security Analyst Underreaction and Post-Earnings-Announcement Drift

Abstract:     
We examine whether analysts more fully incorporate prior earnings and returns information in their current quarter forecasts as their experience following a firm increases. Prior research suggests that various financial anomalies are related to investors' inability to rationally process historical earnings and price information. In particular, analysts' inability to efficiently incorporate the serial correlation in earnings surprises provides at least a partial explanation for post-earnings-announcement drift. Measuring analyst firm-specific forecasting experience as the number of prior quarters for which the analyst has issued an earnings forecast for the firm, we find that analysts underreact to prior earnings information less as their experience increases. We also find that post-earnings-announcement drift associated with firms with a more experienced analyst following is less than that for firms with a less experienced analyst following. This result, in conjunction with the finding that underreaction declines as analysts gain experience, suggests that the efficiency of a firm's market price is affected by the aggregate experience level of its analyst following. Our findings also provide evidence on one potential source of the superior earnings forecasting performance of more experienced analysts, the more efficient use of prior earnings information.

Keywords: Security analysts; Underreaction; Post-earnings-announcement

JEL Classifications: M41, G14, G29

Working Paper Series