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Rationalizing forecast inefficiency

Author

Listed:
  • Charles G. Ham

    (Washington University in St. Louis)

  • Zachary R. Kaplan

    (Washington University in St. Louis)

  • Zawadi R. Lemayian

    (Charles River Associates)

Abstract

We show analysts’ own earnings forecasts predict error in their own forecasts of earnings at other horizons, which we argue provides a measure of the extent to which analysts inefficiently use information. We construct our measure by exploiting two sources of variation in analysts’ incentives: (i) more recent forecasts have greater salience at the time of the earnings release so accuracy incentives are higher (lower) at shorter (longer) forecast horizons and (ii) analysts have greater incentives for optimism (pessimism) at longer (shorter) horizons. Consistent with these incentives affecting the incorporation of information into forecasts, we document (i) current year forecasts underweight (overweight) information in shorter (longer) horizon forecasts and (ii) the mis-weighting is more pronounced when recent news is negative—when analysts have greater (weaker) incentives to incorporate the news into shorter (longer) horizon forecasts. Finally, returns tests suggest that forecasts adjusted for the inefficiency we document better represent market expectations of earnings.

Suggested Citation

  • Charles G. Ham & Zachary R. Kaplan & Zawadi R. Lemayian, 2022. "Rationalizing forecast inefficiency," Review of Accounting Studies, Springer, vol. 27(1), pages 313-343, March.
    • Handle: RePEc:spr:reaccs:v:27:y:2022:i:1:d:10.1007_s11142-021-09622-8
    DOI: 10.1007/s11142-021-09622-8
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