Corporate Misconduct and Analyst Forecasting Accuracy: Evidence from China

ABSTRACT

This paper studies the impact of corporate misconduct on analyst forecasting accuracy in emerging markets. Using a unique dataset from China, we find that analyst forecasting accuracy decreases when firms are involved in corporate misconduct. We address potential endogeneity by employing the propensity score matched (PSM) procedure and IV regression, and our findings are proven robust. Channel analyses show that corporate misconduct is related to the increased earnings management, weak internal control quality, the reduction in site visits by institutional investors and coverage by star analysts, indicating that our results are driven by a worsened information environment for analysts. Further tests reveal that firms who commit more corporate misconduct, more severe misconduct, or information disclosure violations result in less reliable analyst forecasting accuracy. Thus, our research provides policy implication by showing that corporate irregularities reduce information efficiency of capital market and disrupt the market integrity.

KEYWORDS:

• Corporate misconduct
• analyst forecasting accuracy
• Chinese capital market

JEL:

• M50
• G14
• G34

Disclosure Statement

The authors declare that they have no known competing financial interests or personal relationships that could have appeared to influence the work reported in this paper.

Supplementary Material

Supplemental data for this article can be accessed on the publisher’s website

Notes

1. Fraudulent activities, such as inside trading, self-dealing, and non-disclosed information, have been detected in many Chinese-listed companies (Chen et al. 2006).

2. Extant studies have shown that corporate misconduct leads to the following results: penalties from a regulatory body; decline in the stock price (Firth, Rui, and Wu 2011; Jory et al. 2015); reputational losses (Johnson, Xie, and Yi 2014); increased cost of capital (Chava, Huang, and Johnson 2018; Graham, Li, and Qiu 2008; Hutton, Peterson, and Smith 2014); increased probability of executive turnover (Aharony, Liu, and Yawson 2015)

3. The CSRC is responsible for exercising centralized and unified regulation over China’s securities markets. The CSRC can implement a wide variety of administrative sanctions against firms committing fraud. The two domestic stock exchanges in China, namely, SHSE and SZSE, can also take enforcement actions, such as warnings and condemnations, on fraudulent activities that are normally minor and less severe.

4. Consistent with previous studies (Kong, Liu, and Liu 2020; Lang and Lundholm 1996; Li et al. 2020), profitable young firms and those with more institutional ownership, will experience higher analyst forecasting accuracy, thus lower analyst forecasting errors. We find a negative relationship between the number of analysts following the firm and the number of analyst forecasting errors, in line with the fact that larger analyst coverage is associated with better forecasting accuracy.

5. Firms from a similar industrial environment may have similar operating characteristics. However, the misbehavior of industry peer firms is beyond the control of a given firm and less likely to be closely correlated with analyst forecasting accuracy about the given firm.

6. Forecasting accuracy can significantly impact the probability of selection as a star analyst. Additionally, relatively accurate forecasters are more likely to experience favorable career outcomes, such as moving up to a high-status brokerage house (Hong and Kubik 2003).

Additional information

Funding

This work was supported by the National Social Science Foundation of China (Grant no.: 21BJY079)