Do Product Market Threats Affect Analyst Forecast Precision?

Abstract

We examine how product market threats influence the precision of financial analyst forecasts. Greater competitive threats may make forecasting more difficult by increasing the uncertainty regarding future cash flows and by influencing the quality of financial disclosure. Using a firm-specific measure of product market threats (product fluidity; Hoberg et al., 2014), we find that analysts are more likely to be less precise forecasting future earnings for highly fluid firms and that the lack of precision is not fully explained by performance volatility. Our findings further suggest that firms with fluid products have lower accruals quality and that they are more likely to withheld information regarding contract terms and sales from major customers. The path analysis confirms the relevance of the information channel in explaining the negative relation between product fluidity and analysts' precision. Cross-sectional analysis further suggests that the effect of product fluidity on analyst forecasts is more pronounced when firms have flexibility in disclosure choices. Using significant changes in tariff rates as a quasi-natural experiment, we find that analyst forecast precision is significantly lower following tariff reductions.

Keywords: security analysts, product market threat, performance volatility, disclosure quality

JEL Classification: G24, G28, M41, L4