Does Coverage by Long-term Growth Forecasting Analysts Mitigate Market Underreaction to Information about Innovative Efficiency?

Abstract

Prior research finds that investors have difficulty pricing corporate innovation. This paper investigates the role of long-term growth forecasting financial analysts in the efficiency of stock prices and consensus sell-side analyst forecasts, with respect to information about firms’ innovative efficiency (IE). We find that, on average, like stock prices, financial analysts’ consensus earnings and target price forecasts reflect underreaction to IE-related information. We also find that evidence of analyst and investor underreaction is limited to R&D-intensive firms not followed by long-term growth forecasting analysts. We investigate two alternative perspectives on the mechanism underlying these results. The underreaction-mitigation perspective argues that long-term growth forecasting analysts cultivate increased analyst and investor attention to IE-related information and its implications for research-intensive firms’ near- and long-term prospects; thereby, mitigating underreaction in stock prices and in consensus analysts’ earnings and target price forecasts. The offsetting-bias perspective argues that optimistically biased long-term growth forecasts beget optimism in stock prices and consensus analysts’ forecasts, which, in turn, offsets investor and analyst underreaction giving the appearance of underreaction dissipation for firms followed by long-term growth forecasting analysts. Overall, the weight of the evidence from a battery of tests favors the underreaction-mitigation perspective.

Keywords: Innovation, Patents, Long-term growth, Analysts’ forecasts, Market efficiency

JEL Classification: G14, M41