Conservatism, Analyst Ability, and Forecast Error: Evidence on Financial Statement Users' Ability to Account for Conservatism

48 Pages Posted: 23 Nov 2007 Last revised: 23 Oct 2014

Date Written: October 14, 2014

Abstract

We posit that, because incorporating the effect of accounting conservatism on earnings forecasts likely requires a higher degree of sophistication, the ability to adjust earnings forecasts for conservatism should vary across security analysts. Consistent with this conjecture, we find that less experienced analysts are less able to account for the effect of conservatism when forecasting earnings. More specifically, we find that the initial optimism in analyst forecasts increases with accounting conservatism and that this relation significantly decreases with analyst experience. This finding has several implications. First, it indicates that the lack of sophistication by some analysts is likely one reason for the apparent bias in the initial forecast documented. Second, it suggests that conservatism could under certain circumstances result in stock mispricing. Third, it calls for a greater emphasis on the cross-sectional determinants of conservatism in accounting and financial statement analysis curriculums.

Keywords: Accounting conservatism, analyst forecast error

JEL Classification: M41, M44, G29

Suggested Citation

Louis, Henock and Lys, Thomas Z. and Sun, Amy X., Conservatism, Analyst Ability, and Forecast Error: Evidence on Financial Statement Users' Ability to Account for Conservatism (October 14, 2014). Available at SSRN: https://ssrn.com/abstract=1031981 or http://dx.doi.org/10.2139/ssrn.1031981

Henock Louis

Pennsylvania State University - Smeal College of Business ( email )

University Park, PA 16802-3306
United States
814-865-4160 (Phone)
814-863-8393 (Fax)

Thomas Z. Lys

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Department of Accounting & Information Systems
Evanston, IL 60208
United States
847-491-2673 (Phone)
847-467-1202 (Fax)

Amy X. Sun (Contact Author)

University of Houston ( email )

Bauer College of Business
334 Melcher Hall, 390H
Houston, TX 77204
United States
7137435682 (Phone)

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