Patricia C. O'Brien

Self-Selection and Analyst Coverage

We examine implications of the conjecture that analysts announce recommendations and forecasts selectively, based upon whether their information about the firm is favorable. We propose this as an alternative to the common assumption that analysts introduce bias into their forecasts, and provide empirical evidence on this alternative. An effect of selective reporting is that ex post observed distributions of earnings forecast errors appear over-optimistic, even if each forecast is unbiased ex ante. This occurs because high forecasts are both more likely to be observed and more likely to be over-optimistic than low forecasts, for any given realization. We find strong evidence supporting the self-selection conjecture in analyst recommendations, and generally consistent evidence in analyst forecast errors. We also document that analysts avoid issuing negative information by sparse use of sell recommendations and by delaying downgrades, but not by avoiding downgrades altogether.

Discussion of Earnings Management through Transaction Structuring: Contingent Convertible Debt and Diluted Earnings per Share

Neutrality means that either in formulating or implementing standards, the primary concern should be the relevance and reliability of the information that results, not the effect that the new rule may have on a particular interest.... To be neutral, accounting information must report economic activity as faithfully as possible, without coloring the image it communicates for the purpose of influencing behavior in some particular direction. [emphasis in the original] (FASB [1980, para. 98-100])

The median of the maximum entropy distribution

Abstract When the sample size n is even, the median of the maximum entropy (ME) distribution is identical to the conventional sample median (the arithmetic mean of the two middle observations). When n is odd, these medians differ. For odd-sized samples from a normal distribution, the ME median has smaller mean square error than the sample median.

Discussion of the Relative Information Content of Accruals and Cash Flows: Combined Evidence at the Earnings Announcement and Annual Report Release Date

In contrast to the usual research design for event studies of earnings releases, in which a single event window around the earnings announcement is examined, Wilson distinguishes two discrete events associated with year-end information releases: the Wall Street Journal (WS) announcement of earnings and revenues and the later filing of complete financial statements (FS), including funds flows and accruals. Distinguishing these two events, in principle and by the sample selection, allows him a novel test for incremental information content of events which are nearly simultaneous. Participants noted that, in the light of the informativeness of announcements simultaneous with earnings releases, such as prospective comments by management as reported by Hoskin, Hughes, and Ricks [1986], the predictive equations (2) through (5) may omit important predictive information. Moreover, if more than two pieces of information released at the WS date (i.e., more than earnings and revenues) could be

The quartiles of the maximum entropy distribution

Abstract The quartile points and interquartile range of the maximum entropy (ME) distribution and sample distribution are compared, using expected values for sampling from a standard normal population. For sample sizes n ⩽20 such that the sample quartile points are uniquely defined, the ME quartile points and interquartile range are found to have lower mean-squared error (MSE).

Discussion--The Predictive Value of Analyst Characteristics

Brown and Mohd build on a solid foundation of earlier research, which demonstrates that certain analyst characteristics are associated with more accurate earnings forecasts. They take a natural next step and ask whether these same characteristics are useful, or could be useful, to identify ex ante the analysts who will be more accurate forecasters. By and large they find that the answer is “no”that analyst characteristics, while descriptive in-sample, are not predictive out-ofsample. To explore out-of-sample performance, Brown and Mohd use two criteria from Foster (1977): (1) How well can we predict the next in the series? and (2) How closely associated are analysts’ earnings forecast errors with investors’ surprise at the earnings announcement? Their benchmark model uses only one characteristic, the age of the forecast at the end of the fiscal quarter (equivalently, the horizon of the forecast at the time the analyst made it). They show that a simple combination using this one characteristic dominates more complex and more data-intensive regression models based on multiple traits. I focus my discussion of Brown and Mohd’s research on two questions suggested by their results: (a) Should we now mistrust the earlier research that idendetriment?

Reliability Makes Accounting Relevant: A Comment on the IASB Conceptual Framework Project

Abstract In July 2013, the International Accounting Standards Board (IASB) welcomed comments to their discussion paper A Review of the Conceptual Framework for Financial Reporting. We argue that the IASB should revisit its decisions about the concepts of reliability and prudence, to address the inherent accounting issue of moral hazard. Within the contexts of goodwill and securitization accounting, we illustrate how reliability and prudence can help standard-setters to identify standards that can address moral hazard. We further illustrate the pervasiveness of moral hazard, using the context of executive compensation arrangements. Ultimately, we conclude that a strong conceptual framework should enhance the credibility of financial reporting. We view this as the fundamental role of accounting.

Financial Analysts and Their Contribution to Well-Functioning Capital Markets

Well-functioning capital markets rely on a complex set of institutions and participants that ensure capital is allocated to its best possible use, and that information flows between firms receiving capital and the investors who provide it. In this manuscript, we endeavor to understand whether, how, and under what circumstances sell-side research contributes to the functioning of capital markets. We review major findings in the literature, address significant regulatory and technological changes, and offer suggestions for future research.