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Mimicking and Herding Behaviors among U.S. Investment Analysts: Implications for

Market Reactions to Actual Earnings Announcements

Liem Nguyen

Westfield State University

Judy K. Beckman and Henry Oppenheimer

University of Rhode Island

AAA Atlanta Annual Meetings August 6, 2014

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Introduction

CVS

Institutional Investors,

Regulators, Credit Rating

Agencies, Suppliers, etc.

Analysts

Management

BackgroundIntroduction

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Management Voluntary Disclosure

– “CVS Caremark (CVS) issued weak 2011 earnings guidance, and its shares fell 6% in morning trading. CVS posted fourth quarter earnings of 80 cents, versus expectations for 81cents” Barron’s February 3, 2011

– Tyco (TYC) now expects earnings of 30 cents to 33 cents a share instead of the 45 cents to 47 cents guidance it gave in July, chief executive Ed Breen said in his first conference call with the company's investors.” AP September 2005.

BackgroundIntroduction

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Introduction

The Sequence of Management Annual Earnings Guidance and Analyst’s Estimates

Analyst’s Consensus Number

(PRIOR)

First Analyst’s Consensus Number

(FIRST)

Mimicking occurs when the amount is

within 1 cent of management guidance

Management Announces Annual Earnings Guidance

Actual Annual Earnings Is

Released

(GUI) (ACT)

Last Analyst’s Consensus Number

(LAST)

$3.50 $3.45 $3.40

$3.40 $3.42

Herding occurs when the subsequent analysts issue

forecasts within 1 cent of the first

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Literature: Meetable/Beatable Forecasts (Mimicking)

Literature

• Skinner (1994) – Managers may preempt announcement of negative

earnings surprises to reduce the potential costs of shareholder suits

• Soffer et al. (2000) - short-term management earnings guidance tends to be downwardly biased

• Matsumoto (2002) and Richardson, Teoh, and Wysocki (2004) - firms “walk” analysts toward beatable earnings forecasts via their earnings guidance disclosures

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Literature: Management Incentives

• Baik and Jiang (2006)– Management dampens analysts’ earnings expectations

with pessimistic quarterly guidance when their firms:– Have high growth opportunities,– operate in a high-litigation industry,– have transient institutional ownership.

– All factors above are associated with pessimistic management guidance because of the costs of missing the consensus of analysts forecasts.

Literature

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Literature: Herding Behaviors

• Trueman (1994) - Math models predict that an analyst prefers to release an earnings forecast that is close to prior earnings expectations even when his/her own information justifies a more extreme forecast.

• Hong, Kubik, and Solomon (2000) - find that more experienced analysts are more likely to issue bold forecasts than are less experienced analysts and that brokerage firms are more likely to discharge the less experienced analysts for inaccurate or bold forecasts

Literature

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Literature: Herding Behaviors

Literature

• Clement and Tse (2003, 2005)

- find that analyst characteristics are associated with forecast accuracy for both bold and herding forecasts

• Gleason and Lee (2003)

- bold forecast revisions generate stronger return responses than do herding forecast revisions

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Literature: Herding Behaviors and Extreme Earnings Surprises Trueman (1994, p. 98)

When herding is observed among analysts:

Extreme surprise announcements of actual earnings => smaller stock price reactions than would be expected from analysts using information in an an unbiased manner to produce their forecasts.

Reasoning: Investors recognize the possibility that an analyst actually had information that justified a more extreme forecast.

Consequently, large earnings “surprises” do not surprise investors as much as if they had taken the announced forecast at face value.

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Literature: Influence of Regulation FD

• Findlay and Mathew (2006)– After implementation in October 2000 of US. SEC

Regulation Fair Disclosure (Reg. FD), analyst forecast accuracy declines overall, but analysts that were less accurate (more accurate) before Reg. FD improve (become less accurate) after its implementation

• Bailey, Li, Mao, and Zhong (2003) – find that after the passage of Regulation FD, analyst

forecast dispersion increases

Literature

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Research Motivation

How do analysts revise their estimates conditional on management earnings guidance releases?

How do following analysts revise their estimates when faster analysts revise their estimates following management earnings guidance?

Does Regulation Fair Disclosure change the way analysts revise their estimates?

Do analyst herding behaviors result in market reactions to actual earnings announcements as predicted by Trueman (1994)?

Research MotivationIntroduction

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Data and Methodology

Data and Methodology

• First Call (1995 – 2009)– Annual earnings per share (EPS) management

guidance – Omit guidance events that occur after the fiscal year end

but before the earnings announcement– Mid-point of the earnings guidance if given as a range– Omit observations without CUSIP– Neutral/Negative/Positive Surprises: the guidance qualifies as

a positive (negative) surprise when it is higher (lower) than the current expectation based on the last analyst’s consensus update prior to the guidance

– Examine analysts forecast revisions issued within 7 days of management guidance

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Table 1 – Comparison of Management Guidance Events for Annual v. Quarterly Earnings

Year ANNUAL QUARTERLYNegative Neutral Positive Total Negative Neutral Positive Total

1995 29 321 15 365 231 407 33 6901996 76 406 25 507 538 522 88 1,1831997 121 573 50 744 775 756 146 1,6811998 314 978 112 1,404 1,210 1,022 217 2,8431999 358 990 114 1,461 1,067 721 239 3,1432000 415 1,105 187 1,707 1,251 1,026 350 3,3602001 855 2,246 509 3,609 2,482 2,246 595 6,2602002 722 3,022 760 4,502 1,719 2,517 830 5,8802003 766 3,404 696 4,866 1,568 2,341 653 5,0952004 876 3,930 812 5,617 1,588 2,449 892 5,4322005 860 3,876 733 5,469 1,629 2,036 684 4,6512006 1,047 3,864 788 5,696 1,621 1,853 732 4,5742007 732 2,898 1,770 5,389 1,224 1,716 777 3,8562008 31 260 4,985 5,276 121 711 2,479 3,3112009 25 178 3,847 4,050 110 482 2,065 2,657

Total 7,277 28,051 15,403 50,662 17,134 20,805 10,780 54,616

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Measuring Mimicking and Herding

The Sequence of Management Annual Earnings Guidance and Analyst’s Estimates

Analyst’s Consensus Number

(PRIOR)

First Analyst’s Consensus Number

(FIRST)

Mimicking occurs when the amount is

within 1 cent of management guidance

Management Announces Annual Earnings Guidance

Actual Annual Earnings Is

Released

(GUI) (ACT)

Last Analyst’s Consensus Number

(LAST)

$3.50

$3.38

$3.40

$3.40 $3.42

Herding occurs when the subsequent analysts issue

forecasts within 1 cent of the first

$3.39

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Clement and Tse (2005, JF) and Gleason and Lee (2003, TAR) Measurement

Bold forecasts

Analyst’s prior

forecast

Herding forecast

Prior consensus forecast

Bold forecasts

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Hypotheses Related to Mimicking

Hypotheses

• H1-1: Analysts are less likely to mimic management’s earnings guidance for firms which ultimately experience losses than for other firms.

• H1-2: Analysts are less likely to mimic management’s earnings forecasts when following firms with higher potential litigation costs than for firms without this potential.

• H1-3: Analysts are less likely to mimic management’s earnings guidance for growth firms than for other firms.

• H1-4: Analysts are less likely to mimic management’s earnings guidance after the implementation of Regulation Fair Disclosure than they were before the implementation.

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Hypotheses Related to Herding

Hypotheses

• H2-1: Following analysts are less likely to herd if the first analyst mimics management’s earnings guidance.

• H2-2, 3, and 4: Analysts are less likely to herd together for• -2 loss firms, -3 high litigation firms, -4 growth firms

• H2-5: Analysts are more likely to herd after the implementation of Regulation Fair Disclosure than before.

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Hypothesis Related to Herding and Market Reaction to Earnings Announcements

H3: Under extreme surprise outcomes from actual earnings announcements, the overall market reaction is less intense if analysts previously herded their forecasts following the management earnings guidance than it is when herding was not observed among analysts in response to management earnings guidance.

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Empirical Results

Empirical Results

Analyst’s revision dates after the release of Management Earnings Guidance (1995-2009)

1 2 3 4 5 6 7 8 9 10 110.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

Frequency of dates of analyst's revision after the release of MEG

Date

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Empirical Results

Empirical Results

Figure 3A: Earnings difference between analyst’s estimates and management earnings guidance (1995-2009)

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Empirical Results

Empirical Results

Figure 3B: Earnings difference between management earnings guidance and actual earnings (1995-2009)

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Descriptive Statistics (n = 67,595)

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Logit regression of analysts’ mimicking reaction to management annual earnings guidance (1995-2009)

Empirical Results

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Table 6 - Logit regression of following analysts’ herding reaction to first analyst’s estimates after management annual earnings guidance (1995-2009)

Empirical Results

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Empirical Results

Empirical Results

Model 3 - Linear regression of market reactions to actual earnings announcement for extreme earnings surprise of 10% or more (1995-2009)

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Table 7 - Linear regression of market reactions to actual earnings announcement for extreme earnings surprise (1995-2009)

Empirical Results

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Conclusion

• Analysts are less likely to mimic their estimates– higher litigation potential firms– growth firms– loss firms– After Regulation FD

• Analysts are less likely to herd their estimates– When the first analyst mimics– Before Regulation FD

• Confirmation of Trueman (1994) theory: Market reacts less intensively to actual earnings announcements of extreme (top and bottom 10%) surprises after observing analysts’ prior herding behavior.