The Association Between Accounting Conservatism and Analysts’ Forecast Inefficiency
Asia-Pacific Journal of Financial Studies, Forthcoming
40 Pages Posted: 22 Jan 2010
Date Written: January 20, 2010
We find that analysts’ earnings forecasts do not fully impound the implications of accounting conservatism. Forecast optimism is negatively associated with the magnitude of beginning-of-year balance sheet reserves (BSR), which are associated with conservative accounting in prior years. However this result vanishes once we allow for the negative association, documented in a number of prior studies, between BSR and Basu’s (1997) asymmetric timeliness (AT) measure of conservatism. After controlling for this association, we find that forecasters’ under-reaction to bad vs. good news is negatively associated with the magnitude of BSR. We obtain similar results after allowing for the positive association between AT and Khan and Watts’ (2009) C_Score, which has been documented only recently. Our results are thus consistent with a subtle form of inefficiency of forecasts with respect to accounting conservatism, viz., analysts do not fully appreciate that the earnings of companies with lower BSR or higher C_Score are likely to be both (a) lower relative to forecast and (b) more asymmetrically timely than the earnings of companies exhibiting higher BSR or lower C_Score.
Keywords: Accounting conservatism, analyst earnings forecasts, inefficiency in analyst earnings forecasts
JEL Classification: M41
Suggested Citation: Suggested Citation