Do voluntary disclosures of product and business expansion plans impact analyst coverage and forecasts?

Abstract

We investigate whether voluntary disclosures of product and business expansion plans affect analyst coverage and forecasts. We find that the level of analyst coverage is positively associated with the incidence of disclosures of product and business expansion plans. We also find that product and business expansion disclosures increase the informativeness of analyst earnings forecasts. We find no evidence that product and business expansion disclosures increase analyst forecast errors. Overall, our study contributes to understanding the role of product and business expansion disclosures in analyst forecast behaviour.

Keywords:

• nonfinancial disclosures
• analyst coverage
• forecast informativeness
• forecast errors

JEL classification:

• G12
• G14
• G24
• M41

Acknowledgements

We are grateful to the editors and referees for their very constructive comments and suggestions. We also thank Peter Joos and conference participants at 2016 American Accounting Association annual meeting and 39th European Accounting Association annual meeting for their helpful comments. Part of the research was conducted when Guanming He and Xixi Dai were affiliated with the University of Warwick. All errors remain our own.

Disclosure statement

No potential conflict of interest was reported by the authors.

ORCID

Guanming He http://orcid.org/0000-0002-4879-6795

Notes

1 The PBE disclosure itself facilitates outsiders' learning over a firm's fundamentals and performance, and thereby helps outsiders infer future earnings and make better forecasts and valuations. Put differently, though a disclosure per se has no impact on a firm's future earnings, but it could have an impact on the way outsiders interpret a firm's performance and form an expectation about a firm's future earnings.

2 We end our sample period in the year 2012 because of the data availability on PBE disclosures.

3 Analysts’ role in contributing to stock price efficiency is still a debatable issue in the literature. See Frankel et al. (2006), for example, for the detailed review over this literature.

4 The definitions of the product and business expansion plan disclosures follow Capital IQ’s definitions. Capital IQ is a division of Standard and Poor’s.

5 It is worth noting that the communications of private information between analysts and firm management are not fully prevented by Reg. FD (e.g. Soltes 2014, Brown et al. 2015). That said, it is plausible to suggest that given potential reputational and/or legal penalties for non-compliance with Reg. FD, the private information communications between analysts and insiders, albeit not eliminated completely, are limited, as suggested in a large body of the Reg. FD literature (e.g. Koch et al. 2013).

6 It is plausible that PBE disclosures do not reduce some unsophisticated investors’ perceived uncertainty about corporate PBE activities. However, we focus on examining analysts’ (rather than investors’) responses to PBE disclosures, and analysts are supposed to be more sophisticated in information processing than general investors (Chandra et al. 1999, Rajgopal et al. 2003). As such, we posit that PBE disclosures are likely to reduce analysts’ perceptions about uncertainty arising from PBE activities.

7 We change the matching ratio from one-to-one to one-to-two/one-to-three in our caliper propensity score matching, and obtain similar results and insights from all the related empirical tests. Nor our results change qualitatively if we employ a nearest-neighbourhood propensity-score-matching approach to balance the treatment sample and control sample groups.

8 We measure analyst coverage and forecasts based on the window starting from the beginning of the third fiscal quarter, because analysts are reluctant to issue/revise their annual earnings forecasts in the first two fiscal quarters (e.g. Stickel 1989). Accordingly, our PBE disclosure variable is measured based on the window of the first two fiscal quarters. All our results remain qualitatively the same if we alternatively use the third (fourth) fiscal quarter as the measurement window for PBE disclosures (for analyst coverage and forecasts).

9 Our results remain qualitatively the same if the frequency of PBE disclosures over the first two fiscal quarters is used as the treatment variable for the multivariate tests.

10 The fundamental determinants of the firm-level analyst coverage are the expected costs and benefits to analysts of covering a firm (Bhushan 1989, Lang and Lundholm 1996, Frankel et al. 2006). Analysts can obtain the benefit of enhanced industry knowledge only when they cover a considerable amount of firms in the same industry. It is plausible that industrial product market competition drives the industry-level analyst coverage. But our study of the association between PBE disclosures and analyst coverage pertains to a firm-level analysis. Thus, we expect that industrial market competition would not have a direct impact on the firm-level analyst coverage.

11 We use the last forecast of EPS for a fiscal year for three reasons. First, it reflects analysts’ ability to aggregate complex information (inclusive critically of PBE information therein) and to translate it into an output in a form that is more informative to and more demanded by investors. Second, it represents analysts’ most updated expectations about a firm’s future earnings and hence might be valued the most by outsiders. Third, it facilitates a relatively clear-cut lead-lag setting to establish a causal relation between PBE disclosures and analyst forecast informativeness. We obtain qualitatively the same results if the first forecast of EPS after the beginning of the third fiscal quarter is used alternatively to define car.

12 For the same reasons as mentioned in note 11, we use the last forecast of EPS for a fiscal year to define error. Our results remain qualitatively the same if the first forecast of EPS after the beginning of the third fiscal quarter is used to define error.

13 The insignificant association between analyst forecast errors and the incidence of PBE disclosures could imply that analysts assign the same weight to the disclosures in forecasting as the weight attributable to this PBE information in the earnings generating process. This possibility, however, is less likely to systematically exist, not least as prior research documents that (i) there exists significant heterogeneity in the value-relevant information sets that are held and processed by different analysts (e.g. Lang and Lundholm 1996); (ii) the forecasting models used by different analysts differ substantively (e.g. Lang and Lundholm 1996, Ramnath et al. 2008); (iii) the sophistication in, and capability of, processing value-relevant information vary considerably across different analysts (e.g., Clement et al. 2007, Ramnath et al. 2008).

14 Analyst efforts are unobservable and are difficult to measure and test empirically in an acceptable manner in an archival study. Any empirical proxy for analyst efforts inevitably involve nontrivial measurement errors, which are thus likely to yield spurious results and inferences in any empirical analysis. We therefore leave this issue as an avenue for future research in an experimental setting.