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Inside the 'Black Box' of Sell-Side Financial Analysts

63 Pages Posted: 4 Mar 2013 Last revised: 24 Jan 2015

Lawrence D. Brown

Temple University - Department of Accounting

Andrew C. Call

Arizona State University (ASU) - School of Accountancy

Michael B. Clement

University of Texas at Austin - Department of Accounting

Nathan Y. Sharp

Texas A&M University - Department of Accounting

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Date Written: October 28, 2014

Abstract

Our objective is to penetrate the “black box” of sell-side financial analysts by providing new insights into the inputs analysts use and the incentives they face. We survey 365 analysts and conduct 18 follow-up interviews covering a wide range of topics, including the inputs to analysts’ earnings forecasts and stock recommendations, the value of their industry knowledge, the determinants of their compensation, the career benefits of Institutional Investor All-Star status, and the factors they consider indicative of high-quality earnings. One important finding is that private communication with management is a more useful input to analysts’ earnings forecasts and stock recommendations than their own primary research, recent earnings performance, and recent 10-K and 10-Q reports. Another notable finding is that issuing earnings forecasts and stock recommendations that are well below the consensus often leads to an increase in analysts’ credibility with their investing clients. We conduct cross-sectional analyses that highlight the impact of analyst and brokerage characteristics on analysts’ inputs and incentives. Our findings are relevant to investors, managers, analysts, and academic researchers.

Keywords: sell-side analysts, analyst inputs, analyst incentives, private communication, analyst compensation, industry knowledge

JEL Classification: M40, M41, G20, G23, G24, G28

Suggested Citation

Brown, Lawrence D. and Call, Andrew C. and Clement, Michael B. and Sharp, Nathan Y., Inside the 'Black Box' of Sell-Side Financial Analysts (October 28, 2014). Journal of Accounting Research, Forthcoming; Fox School of Business Research Paper No. 15-042. Available at SSRN: https://ssrn.com/abstract=2228373 or http://dx.doi.org/10.2139/ssrn.2228373

Lawrence Brown

Temple University - Department of Accounting ( email )

Philadelphia, PA 19122
United States

Andrew Call

Arizona State University (ASU) - School of Accountancy ( email )

Tempe, AZ 85287
United States

Michael Clement (Contact Author)

University of Texas at Austin - Department of Accounting ( email )

2110 Speedway, Stop B6400
Austin, TX 78712
United States
512-471-0332 (Phone)
512-471-3904 (Fax)

Nathan Sharp

Texas A&M University - Department of Accounting ( email )

4353 TAMU
College Station, TX 77843-4353
United States
979-845-0338 (Phone)

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