Financial Statement Analysis

Topics: Forecasting, Optimism, Correlation and dependence Pages: 2 (780 words) Published: May 16, 2015
Financial Statement Analysis

Assignment 2: “Do Security Analysts Speak in Two Tongues?” 1. Research question
The aim of this paper is to explain why security analysts give overoptimistic recommendations most of the time on the stock they cover. Two explanations seem plausible. According to the first, analysts truly believe the stock they chose, will perform outstandingly. The second explanation states that analysts intentionally over estimate the stocks in order to satisfy their clients and encourage investors to buy the stock. Analysts would behave like this because they receive commissions in line with the profits they generate for the corporate finance department.

To analyze this question, it is important to make the difference between affiliated and unaffiliated analysts since they do not always behave in the same way. Affiliated analysts work for an investment bank that underwrites stocks of the covered company. Unaffiliated analysts work for their own account.

2. Sample
The authors collected the necessary data, i.e. analyst recommendations, annual and quarterly earnings forecasts and other information about the analysts and brokerage firms, from the Institutional Brokers' Estimate System (I/B/E/S).

The main sample period starts from February 1994 until December 2002. A shorter sample period, which goes only until July 2001, is also analyzed to exclude some potential “scandal effects” from 2001 and 2002 and thus avoid a bias. The main sample includes 2 515 securities for 2 485 firms whereas the shorter sample contains 2 363 securities for 2 338 firms. The I/B/E/S converts the recommendations in a uniform numerical format. The recommendations receive a number on a scale from 1 to 5 where 1 = strong sell and 5 = strong buy.

Regarding the earnings forecasts, the authors mainly focused on the annual earnings forecasts and which are occurring at least 10 days and at most 80 days before the earnings announcement.

3. Methodology
Firstly, the authors...
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