Knowledge that Transforms

Earnings forecasts, Forecast bias, Information gathering

Disclosures, Disclosure policy, Signals, Signal relevance

Auditing, Qualified opinion, Market reaction, Litigation exposure

Maureen McNichols, Patricia C. O'Brien, Self-Selection and Analyst Coverage, Journal of Accounting Research, Vol. 35, Studies on Experts and the Application of Expertise in Accounting, Auditing, and Tax (1997), pp. 167-199

Analyst stock recommendation, Earnings forecast revisions, Stock returns

Accounting education, Project Discovery, Accounting expertise, Knowledge

Fundamental Analysis, Stock price, Fundamental signals, Future earnings

This paper investigates whether sophisticated investors rely more on analyst forecasts than on time-series model forecasts in forming expected earnings. Although analyst forecasts are generally more accurate than time-series model forecasts (e.g., O'Brien [1988]), analyst forecasts are not clearly superior to time-series model forecasts as a proxy for expected earnings (e.g., Brown et al. [1987b]). Recent research has concluded that earnings expectations reflected in stock prices at least partially reflect a seasonal random walk (SRW) model (Bernard and Thomas [1990] and Abarbanell and Bernard [1992]). In particular, Ball and Bartov [1996] find that market earnings expectations incorporate the sign of the serial correlation in seasonally differenced earnings but underestimate the correlation magnitude (see also Maines and Hand [1996]). These findings suggest that at least some market participants ignore public information in forming expected earnings; I examine whether information usage is correlated with investor sophistication and/or the degree to which investors are informed.

Auditing, Audit expertise, Tacit knowledge, Technical knowledge

Taxation, Earnings management, Net operating losses, Income shifting