This study examines analyst forecast errors within the context of stock recommendations. We predict positive forecast error (i.e., optimism) for buy recommendations and negative forecast error (i.e., pessimism) for sell recommendations. We offer two explanations for this prediction: (1) the unconscious tendency to process information in a manner that supports one’s goal, which we refer to as the “objectivity illusion” hypothesis, and (2) the economic incentive to boost trade, which we refer to as the “trade boosting” hypothesis. The pattern of analyst forecast bias we predict (i.e., optimism for buys and pessimism for sells) is opposite in direction to that predicted by the management relations hypothesis—a commonly cited hypothesis for analyst forecast bias. We find broker‐analyst earnings forecast errors are significantly optimistic for buy recommendations and significantly pessimistic for sell recommendations, consistent with the objectivity illusion and trade boosting hypotheses. Our study indicates that the pattern of results reported in prior research (i.e., increasingly optimistic earnings forecasts as the stock recommendation becomes less favorable) is likely driven by a correlated omitted variable, actual earnings. Results of an analysis to distinguish between trade boosting and objectivity illusion appear more consistent with the objectivity illusion.

We use a simulation model for a pharmaceutical R&D program to examine the tradeoff between objectivity and relevance of accounting information under various methods of R&D reporting. A simple capitalization rule, similar to the successful‐efforts method of capitalizing oil and gas exploration costs, provides a stronger relation between accounting information and economic values than immediate expensing of R&D outlays or capitalizing the full cost of outlays. The superior relevance of this “successful‐efforts” method persists even when earnings management is widespread.

This study presents a general approach for selecting comparable firms in market‐based research and equity valuation. Guided by valuation theory, we develop a “warranted multiple” for each firm, and identify peer firms as those having the closest warranted multiple. We test this approach by examining the efficacy of the selected comparable firms in predicting future (one‐ to three‐year‐ahead) enterprise‐value‐to‐sales and price‐to‐book ratios. Our tests encompass the general universe of stocks as well as a sub‐population of so‐called “new economy” stocks. We conclude that comparable firms selected in this manner offer sharp improvements over comparable firms selected on the basis of other techniques.

We investigate the relation between earnings predictability, information asymmetry and the behavior of the adverse selection cost component of the bid‐ask spread around quarterly earnings announcements for NASDAQ firms. While we find an increase in the adverse selection component of the bid‐ask spread on the day of and the day prior to quarterly earnings announcements for firms with less predictable earnings, we find no evidence of such changes for firms with more predictable earnings. During a non‐announcement period, we find that firms with relatively less predictable earnings have consistently higher total bid‐ask spreads than firms with more predictable earnings. This finding suggests that firms with relatively less predictable earnings have a higher cost of equity capital than comparable firms with more predictable earning streams, ceteris paribus. Hence, earnings predictability may be a legitimate concern of managers who wish to minimize their cost of equity capital at least as it pertains to bid‐ask spreads.

This paper examines a real cost of awarding employee stock options. Based on the observation that managers are extremely concerned about earnings‐per‐share dilution in equity related compensation, we predict and find that firms experiencing significant employee stock option (ESO) exercises shift resources away from real investments towards the repurchase of their own stocks. We further find weak evidence of a decline in subsequent firm performance (as measured by return on assets) for several years following the cut in discretionary investments as a result of stock option exercises, though this result is sensitive to the metric used to measure performance. Collectively, our findings indicate that ESO exercises potentially impose a real cost on the firm in terms of foregone investment opportunities.

This paper analyzes annual corporate governance decisions at firms making initial public offerings (IPOs) of common stock between 1996 and 1999. Our objective is to examine relations between firms’ corporate governance decisions and the informativeness of available measures of managerial performance. We consider financial measures such as earnings and stock return, as well as direct monitoring. We collect a sample of IPO firms from the manufacturing, Internet, and technology (non‐Internet) industries, and examine how the use of various performance measures in annual compensation grants and turnover decisions varies with the information environment of the firm and with the extent of venture capital influence. Consistent with prior research that finds earnings are of limited usefulness in firm valuation for Internet firms, we find Internet firms place less importance on earnings and greater importance on stock returns in determining compensation grants than do non‐Internet firms. We also find that compensation grants of firms with little or no venture capital influence display significantly stronger association with accounting and stock performance measures than those of firms with more intense monitoring by venture capitalists. This result is consistent with direct monitoring and the use of explicit performance measures acting as substitute governance mechanisms.