CFA Institute Journal ReviewJuly 2017Volume 47Issue 7
The Effects of Firms’ Information Environment on Analysts’
Herding Behavior (Digest Summary)
Ryan D.LeeceTodd P.WhiteReview of Quantitative Finance and Accounting
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Analysts move as a group toward consensus when those with superior information issue
early earnings forecasts in a firm’s opaque information environment. The authors
study the information environment of firms.
How Is This Research Useful to Practitioners?
Analysts issue forecasts regarding the investability of various firms on the basis of their
research, which includes analysis of both public and private information about the firms.
Analyst forecasts are an important piece of information for both portfolio managers and
professional investors in making investment decisions. The influence of peers on
analysts’ forecasts in an opaque information environment can materially affect the
quality of their forecasts, thus affecting market efficiency.
Prior researchers have empirically proved that less informed analysts follow analysts with
superior information toward consensus to preserve their reputations. The authors study the
influence of firms’ information environment on analysts’ herding behavior.
They hypothesize that consensus-driven reputational herding behavior is positively related
to the proportion of transient (i.e., short-term) institutional investors in a firm. A
higher proportion of transient investors leads to an opaque information environment for a
firm. In such cases, management-issued guidance is less valuable than the private
information collated by analysts. Analysts with superior private information are followed by
other analysts, thus creating a herd mentality regarding the forecasts about firms with less
transparency in reporting fundamentals.
The authors’ second hypothesis states that the percentage of short-term
institutional ownership is inversely proportional to the incidence of analyst revisions
after management-issued guidance. After analyzing 8,315 firm-quarter observations, the
authors find that the results do not support the hypothesized inverse relationship between
transient ownership and analyst revisions.
How Did the Authors Conduct This Research?
The authors collect data on the institutional holdings of transient and long-term investors
over 1998–2007. The sample data on herding behavior cover 2,408 firms, resulting in
8,045 firm-quarter observations. The sample data on analyst revisions cover 2,142 firms,
resulting in 8,315 firm-quarter observations.
Data on management guidance are obtained from the First Call Company Issued Guidance
database, and information around analyst revisions and consensus forecasts is derived from
the First Call Analyst Estimate database. Using the estimated coefficient for transient
ownership and the S-statistic (a measure of herding behavior), the authors
show that analysts with inferior private information who cover transient-owned firms tend to
move with the analysts having superior information, thus forming a consensus rather than
making independent forecasts with their own analyses. They also show that analyst earnings
revisions are meaningful and more likely when dedicated (i.e., long-term) institutional
owners are associated with the firms.
Both public and private information regarding firms’ fundamentals lead to fair price
discovery, which helps improve market efficiency. Very little attention has been given to
the relationship between a firm’s information environment (opaque or otherwise) and
analysts’ propensity to follow the herd. The authors’ research is an important
addition to the literature on the effectiveness of analyst forecasts when a firm’s
information environment is not transparent, which widens the information gap between the
most informed and the least informed.
The authors also focus on the relationship between transient ownership and analyst
revisions after the issuance of management guidance. They find that management guidance by a
firm with dedicated ownership carries weight and probably results in analyst revisions to
earnings forecasts. Dedicated ownership is a good proxy for effective monitoring, and market
participants value information from better monitors of firm management.