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For stock analysts objectivity trumps familiarity

August 1, 2004

For more information, contact: Benjamin Haimowitz,

A perennial question about stock analysts is whether long experience in monitoring the performance of a company and issuing forecasts about it enhances forecast accuracy or diminishes it.

A study presented on August 9 at the Academy of Management's 2004 annual meeting, based on close to a million forecasts of thousands of stock analysts, suggests the latter to be the case.

The authors, Paul Healy, Amanda Cowen, and Boris Groysberg, all from Harvard Business School, pose the issue in these terms:

"Experience could reflect superior private information that analysts develop about a company's economics the longer they follow it, leading to more accurate forecasts. Alternatively, it could reflect selection bias -- better-performing analysts with more accurate and less optimistic forecasts are more likely to be retained.

"However, company experience could also be associated with forecast optimism in a different way. Analysts who follow a company for long periods develop a close relationship with management, making it difficult to challenge or question management's performance. This reduced objectivity is likely to be reflected in relatively more optimistic and less accurate forecasts."

In probing these alternatives, the authors reviewed the forecast records of thousands of stock analysts with respect to near-term earnings, long-term earnings growth, and target prices. They measured forecast optimism through a formula that compared each analyst's forecasts with those of all other analysts covering the same companies. The near-term earnings sample consisted of about 6,500 analysts, while the other two samples consisted of about 4,000 analysts. All told, close to one million forecasts from 1996 through 2002 made up the final sample.

To assess how analysts' length of company experience affects their forecast optimism, the authors calculated for each analyst the number of quarters elapsing between the analyst's first forecast (going back to 1983) regarding a particular company and his or her forecasts from the current period.

They found that for earnings predictions of greater than 90 days and for stock-price forecasts, which are typically for 12 months ahead, longer company experience was associated with significantly greater forecast optimism, which in turn was generally associated with less accuracy.

"This suggests," the authors write, "that analysts who cover a company for longer periods find it more difficult to take a negative longer-term view on the company relative to their peers, either because their relation with management boosts their confidence about management's ability to deliver strong performance or because they rely more heavily on management's input."

In sum, they add, the results suggest that "over time analysts develop relations with management that make it difficult to be independent."

The Academy of Management, founded in 1936, is the largest organization in the world devoted to management research and teaching. It has about 15,000 members in 90 countries, including some 10,000 in the United States. The academy's 2004 annual meeting drew some 7,000 scholars and practitioners to New Orleans for more than 1,000 sessions on a host of issues relating to corporate organization, the workplace, technology development, and other management-related subjects.

Media Coverage:
Financial Times. Analysing reasons to be cheerful. (Saturday, August 14, 2004).
Reuters. Long-time analysts more optimistic: Harvard study. (Monday, August 09, 2004).
The Wall Street Journal. Picking your analysts gets messier. (Friday, August 06, 2004).

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