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
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: Suggested Citation