The effect of CEO turnover on dropped coverage of analysts issuing biased earnings forecasts

ABSTRACT

This study offers evidence on the relationship between analysts’ dropped coverage and CEO turnover, based on analyst forecast bias. The results suggest that analysts with more frequent forecast biases are more likely to drop their covered firms which their CEOs are replaced. Especially as for cases of new CEOs hired from the outside, the effect of analyst biased forecast on analysts’ dropped coverage corresponding with CEOs turnover are stronger. However, this effect is weaker in the post-SOX period (after 2003) than in the pre-Reg FD period (before 2000).

KEYWORDS:

• Analysts’ dropped coverage
• CEO turnover
• biased earnings forecasts
• SOX

JEL CLASSIFICATION:

• M41
• G38
• M41; G30

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

¹ The forecast bias is OP bias defined as the analysts whose first annual earnings forecast issued after the prior fiscal year’s earnings announcement is greater than the actual earnings (optimistic), but whose last annual earnings forecast issued before the current year’s earnings announcement is less than or equal to the realized earnings (pessimistic).

² Forecast accuracy is the absolute gap between the analyst forecast of earnings and actual earnings. One analyst can have a forecast which is near to actual earnings but still below or above actual earnings (forecast bias).

³ See Bailey et al. (2003).

⁴ In fact, Agrawal, Chadha, and Chen (2006), Aubert and Grudnitski (2014), Baik and Nam (2009), Bailey et al. (2003), Heflin, Subramanyam, and Yuan (2003), Herrmann, Hope, and Thomas (2008), and Irani and Karamanou (2003) find that Regulation FD affects the accuracy and dispersion of analysts’ earnings forecasts, while Koh, Matsumoto, and Rajgopal (2008) find that SOX affects the relationship between managerial actions and analyst expectations.

⁵ See the Section 3.2.1.

⁶ Regulation Fair Disclosure (FD) is announced On 23 October 2000. President Bush signs the SOX into law on 30 July 2002.

⁷ Ke and Yu. (2006) find that such biased earnings forecasts enable analysts to obtain privileged information from management. The definition of biased earnins forecasts can see footnote 1.

⁸ The process of selection of matching sample presents in the Section 4.2.

⁹ The difference is positive and significant at the 1 percent and 10 percent levels in t- and Wilcoxon z-tests (t = 8.20 and z = 2.58), respectively.

¹⁰ The difference is positive and significant at 1 percent level in both t- and Wilcoxon z-tests (t = −8.29 and z = 25.41).

¹¹ The difference is positive and significant at 1 percent level in both t- and Wilcoxon z-tests (t = −3.93 and z = 6.11).

¹² The sample has 550 analyst turnover and 435 analyst non-turnover (original analysts’ dropped coverage) observations.

¹³ The sample has 1,030 analyst turnover and 511 analyst non-turnover (original analysts’ dropped coverage) observations.