How reputation affects the quality of analysts’ earnings forecasts

Reputable analysts are less reliant than their peers on corporate earnings guidance, leading to more informative forecasts and improved career prospects

Market analysts sacrifice forecast accuracy when they rely less on earnings guidance from corporate managers, but reputable managers benefit more than their peers by providing more informative forecasts when they do so, new research shows.

Because investors highly value forecasts issued by reputable analysts – and are influenced more by them than by less reputable analysts – their accuracy is of paramount importance and interest to market participants. But reputable analysts’ edge may stem more from their enhanced informativeness than from accuracy, according to the research paper, When does analyst reputation matter? Evidence from analysts’ reliance on management guidance.

While prior research in this area focused on the relationship between consensus analyst forecasts and management guidance in examining its effect on forecast accuracy, there was little understanding of how reputational differences among individual analysts factor into forecast quality. The paper’s authors – Professor Wei Chen and Associate Professor Lili Dai of the School of Accounting, Auditing & Taxation at UNSW Business School and Professor Hun-Tong Tan of the Nanyang Business School at Nanyang Technological University – therefore sought to examine the individual reputation effect.

They found that more reputable analysts rely less on corporate earnings guidance and that all analysts sacrifice accuracy when they do so. However, when reputable analysts deprioritise guidance, they benefit more than their less reputable peers from the increased informativeness of their forecasts. It also enhances their career prospects.

The research underscores the complex interplay between accuracy and informativeness in financial forecasting, with meaningful implications for analysts, managers and investors alike, according to Prof. Chen. It “challenges the conventional focus on forecast accuracy by highlighting the value of informativeness, particularly from reputable analysts who bring new information to the table,” she said.

The researchers also examined the role external conditions like uncertainty and the credibility of guidance play in shaping analysts’ behaviour. These insights can help develop a “more nuanced understanding of the financial forecasting landscape” and foster better communication – and better decision-making practices – among market participants, Prof. Chen said.

Wei Chen UNSW.jpg
UNSW Business School's Professor Wei Chen said the research challenges the conventional focus on forecast accuracy by highlighting the value of reputable analysts. Photo: supplied

Why reputation heterogeneity matters

While previous scholarship had focused on the relationship between aggregated analyst forecasts and earnings guidance, A/Prof. Dai said there was less understanding of the interplay of individual analyst reputation, earnings guidance reliance and forecast quality. “Previous studies have shown that reputable analysts’ forecasts are highly valued by investors, yet there was a gap in knowledge regarding whether these analysts rely differently on management guidance compared with their less reputable peers,” he explained.

The researchers therefore sought to explore that dynamic and investigate how moderating factors such as information uncertainty and the good- or bad-news nature of guidance – described as guidance news valence – might affect it. “Our goal was to shed light on the decision-making processes of reputable analysts and how their actions impact the informativeness and accuracy of their forecasts,” A/Prof Dai said.

Using the Institutional Investor All-America Analyst Award as a signal of analyst quality and applying the two moderating factors, they measured the extent to which individual analysts rely on management guidance. “This is an important question because investors are influenced to a greater extent by the forecasts issued by reputable analysts and use these forecasts as key performance benchmarks to evaluate firms’ reported earnings,” the research paper stated. “From the managers’ perspective, when they intend to manage market expectations though issuing guidance, this objective is less likely to be achieved when reputable analysts do not echo the guided earnings.”

Read more: How do equity analysts learn to make accurate forecasts?

Because the study looks at heterogeneity among individual analysts’ reputations – as opposed to aggregated forecast data – it “allows us to understand the nuanced behaviours and decision-making processes of different analysts”, Prof. Chen explained. “Aggregated studies may obscure important differences and lead to generalised conclusions that do not apply to specific subsets of analysts,” she said.

“By focusing on individual analysts, we can identify how reputable analysts leverage their expertise and resources differently compared with their less reputable peers. This approach also helps us understand the conditions under which the reliance on management guidance varies and the implications of these behaviours on market perceptions and career advancements.”

‘Critical trade-off’ for analysts

An initial key finding from the study was that reputable analysts indeed rely less on management guidance than do their less reputable peers, with that effect more pronounced in higher-uncertainty environments or when guidance contains good news, which is often seen as less reliable.

Moreover, the study showed analysts sacrifice forecast accuracy when they rely less on management guidance – regardless of their reputation – but that reputable analysts benefit more from the increased informativeness of their forecasts. Forecast accuracy is “essentially a means of precision, where a higher accuracy indicates a smaller deviation from the reported earnings”, A/Prof. Dai explained.

Associate Professor Lili Dai in the School of Accounting, Auditing and Taxation at UNSW Business School-min.jpg
UNSW Business School's Associate Professor Lili Dai said that building a reputation gives analysts “far greater flexibility” in their reliance on management guidance. Photo: supplied

In contrast, informativeness is the extent to which a forecast provides information to the market that is new and valuable. “An informative forecast may not necessarily be the most accurate in terms of predicting actual earnings, but it contributes additional insights that help investors make better-informed decisions,” he said.

That a lower reliance on management information reduces forecast accuracy for all analysts but allows reputable analysts to benefit from more forecast informativeness “highlights a critical trade-off”, according to A/Prof. Dai. “When analysts, particularly reputable ones, diverge from management guidance, their forecasts may be less accurate because they do not align with the potentially manipulated earnings targets set by management,” he said. “However, these forecasts become more informative as they incorporate additional private information or alternative analyses that are not reflected in the management’s guidance, thereby offering unique and valuable insights to the market.”

Prof. Chen added: “This means that their forecasts provide more new information that is valuable to the market, even if they are less accurate in matching the actual earnings reported by firms.”

Another insight of particular importance for practitioners is that analysts who depend less on guidance from management are more likely to experience career advancement. “Specifically, these analysts have a higher likelihood of being awarded the prestigious All-American Analyst designation in subsequent years, which has significant implications for their remuneration and career prospects,” Prof. Chen said.

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Implications for practitioners

The findings suggest that building a reputation gives analysts “far greater flexibility” in their reliance on management guidance, according to A/Prof. Dai. That can then lead to their producing more informative forecasts, thereby improving their career prospects. “Analysts should focus on enhancing their reputational capital by providing valuable and unique insights rather than merely aiming for forecast accuracy,” he said, adding that other market stakeholders can also benefit from the study’s findings.

“Investors can benefit from understanding that forecasts from reputable analysts, even if less accurate, often provide more valuable information,” he said. “This knowledge can help investors make better-informed decisions by recognising the additional insights provided by reputable analysts.”

Managers, meanwhile, can benefit by understanding the importance of communicating transparently and credibly with analysts. “Management should be aware that reputable analysts are less likely to simply parrot their guidance and are more inclined to seek out additional information,” Prof. Chen said. “This can impact how managers approach their guidance and communication strategies, particularly in environments of high uncertainty or when issuing good news.”


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