Will Local Analysts Cater to Government Needs in Earnings Forecasts? Evidence from Financial Misconduct in Chinese State-Owned Enterprises

We explore the impact of political factors on local analysts’ earnings forecasts on the basis of a scenario of financial misconduct in Chinese state-owned enterprises (SOEs). The results show that local analysts’ earnings forecasts for SOEs involved in financial misconduct are less accurate and more optimistically biased. Heterogeneity analysis reveals that forecast bias and optimism by local analysts are greater when officials have stronger promotion incentives, when regions are less market-oriented, and when violating SOEs contribute more to taxation and employment. In a further analysis, we find that local analysts who rely heavily on political information will issue more biased and optimistic forecasts on violating SOEs. Although investors perceive the optimistic forecasts of local analysts as less credible, analysts’ catering behaviors can mitigate the negative impact of misconduct on the stock prices of SOEs in the year of occurrence. As information asymmetry is alleviated in longer windows, investors’ views will reverse. Moreover, forecast bias will reduce the likelihood of local analysts attaining star status. Finally, as a reward for catering to government needs, local brokerages whose affiliated analysts have provided optimistic forecasts are more likely to become underwriters in the seasoned equity offerings of SOEs and local government bond issuances. Our study contributes to the literature on factors affecting analyst forecast bias and analysts’ catering behaviors by highlighting the reciprocal relationships between the government and information intermediaries.