Coexistence and Dynamics of Overconfidence and Strategic Incentives
CentER Discussion Paper Series No. 2009-81
42 Pages Posted: 25 Oct 2009 Last revised: 18 Mar 2010
Date Written: October 20, 2009
We present a two-stage model for the decision making process of financial analysts when issuing earnings forecasts. In the first stage, financial analysts perform a fundamental earnings analysis in which they are, potentially, subject to a behavioral bias. In the second stage analysts can adjust their earnings forecast in line with their strategic incentives. The paper analyzes this decision process throughout the forecasting period and explains the underlying drivers. Using quarterly earnings forecasts, we document that throughout the entire forecasting period financial analysts overweight their private information. At the same time, financial analysts behave strategically. They issue initial optimistic forecasts by strategically inflating their forecast. In their last revision, they become pessimistic and strategically deflate their earnings forecast, which creates the possibility of a positive earnings surprise. This analysis of the dynamics of the decision process provides empirical evidence on the coexistence of overconfidence and strategic incentives.
Keywords: financial analysts, earnings forecasts, overconfidence, conflicts of interest
JEL Classification: G14, G17, G24
Suggested Citation: Suggested Citation