How Boldness and Accuracy Affect Analyst Credibility

Published: December 13, 2006 in Knowledge@Emory


On any given day, the business media has analysts upgrading, downgrading, and even scrambling in their quest to report and predict accurately about a company’s financial present and future. Interestingly, analysts are commonly referred to as a group, lumped together as a scrambling herd chasing the rise and fall of the market in their quest for credibility with investors. This behavior has fascinated Goizueta Business School’s Kathryn Kadous, Molly Mercer, and Jane Thayer, all of whom have backgrounds in psychology, as well as business. “We kept reading about analysts herding—when all the analysts are giving the same prediction, it’s not terribly valuable,” notes Kadous, an associate professor of accounting. “Some analysts’ private information may be going unreported. Given that there are many analysts, we set out to identify what makes an analyst more or less credible. We also started thinking about theoretical reasons why they might herd, and we ended up developing a paper from there.”

The result: “Is There Safety in Numbers? The Effects of Forecast Accuracy and Forecast Boldness on Financial Analysts’ Credibility with Investors,” a yet-unpublished collaborative paper by Kadous, Mercer, an assistant professor of accounting at Goizueta, and Thayer, a doctoral student. The paper reports the results of an experiment that examines how analyst forecast accuracy (i.e., how close an analyst’s forecast is to realized earnings) and forecast boldness (i.e. how far the analyst’s forecast is from the consensus forecast) affect investors’ beliefs about the analyst. “There is a lot of research using stock market data showing that analysts who are more accurate do better in their jobs—they are more likely to get promoted, are more likely to be named an all-star analyst and are less likely to get fired. It’s pretty well-established that when analysts are accurate, the market pays attention to them,” notes Kadous. “We wanted to see that if they were accurate and got away from the herd, would the market put even more stock in their reports. Alternatively, if they were bold and they turned out to be wrong, would that be more costly to them? Basically, we wanted to see how being bold, or away from the crowd, would influence the effect of accuracy on what investors think of analysts.”

Drawing on theory from social psychology, Kadous and her colleagues predicted that bold forecasts would tend to be attributed to an analyst’s internal traits, such as their ability and how hard they worked, whereas non-bold forecasts would tend to be attributed to external factors, such as an easy or difficult forecasting environment. “The idea is that if you do something that’s different from what everyone else is doing, it’s more likely to be because of something unique about you, whereas if you do something that’s the same as what everyone else is doing, it’s likely because of the situation.” This directly impacts analysts’ credibility with investors. This pattern of attributions, write the authors, suggests that analysts who make bold forecasts will receive more credit for their accurate forecasts and more blame for their inaccurate forecasts than analysts who make non-bold forecasts. 

The authors conducted research that manipulated forecast accuracy and boldness. In their experiment, 131 MBA students acting as investors assessed analyst credibility and they ranked the importance of three internal and three external characteristics in determining analyst forecast accuracy. The three internal attributes were: the analyst’s ability level, the analyst’s access to company management and the analyst’s effort level. The three external attributes were the ease/difficulty of forecasting earnings for this company, luck, and the stability/instability of macroeconomic conditions.

The researchers find that investors view internal characteristics of the analyst as more important in determining the forecast accuracy of analysts making bold forecasts than of analysts making non-bold forecasts. In contrast, investors view external factors as more important determinants of forecast accuracy for analysts making non-bold forecasts. Investors also view analysts who provide accurate forecasts as more credible than those who provide inaccurate forecasts, and the influence of accuracy on credibility is larger for analysts providing bold forecasts than for those providing non-bold forecasts. Finally, they also find that the credibility cost of being bold and inaccurate exceeds the credibility benefit of being bold and accurate. “The downside is that if you are bold and wrong, you suffer more than you gain than if you’re bold and right,” explains Kadous.

This study, urges Kadous, provides new insights into how analysts develop credibility with investors. “If analysts really want to build a reputation quickly, they might consider being bold because they get a bigger bump up in credibility every time they’re right,” suggests Kadous. “But they really shouldn’t pursue that strategy unless they’re highly confident that they’re right because if they’re wrong, they suffer big-time.” Investors can also draw lessons from this research, adds Kadous. “Analysts shouldn’t be making bold forecasts unless they are pretty confident,” she says. “If analysts know this and behave accordingly, then it makes sense that if you see a bold forecast, it’s probably accurate.”

Bold moves can ultimately benefit both analysts and investors.



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