Stephannie Larocque

Investment Banking Relationships and Analyst Affiliation Bias: The Impact of the Global Settlement on Sanctioned and Non-Sanctioned Banks

We examine the impact of the Global Settlement on affiliation bias in analyst recommendations. Using a broad measure of investment bank-firm relationships, we find a substantial reduction in analyst affiliation bias following the settlement for sanctioned banks. In contrast, we find strong evidence of bias both before and after the settlement for affiliated analysts at non-sanctioned banks. Our results suggest that the settlement led to an increase in the expected costs of issuing biased coverage at sanctioned banks, while concurrent self-regulatory organization rule changes were largely ineffective at reducing the influence of investment banking on analyst research at large non-sanctioned banks.

Forecasting Tax Expense: New Evidence from Analysts

Using recently available pre-tax earnings forecast data from 2003 to 2012, we infer analysts’ income tax expense and effective tax rate (ETR) forecasts and provide the first large-sample evidence on their dispersion and accuracy. Even though managers provide annual ETR estimates each interim quarter, management’s estimates are not equal in information content and analysts do not merely mimic these estimates, consistent with analysts providing incremental information. Analysts’ forecasts are more disperse and less accurate when management’s interim ETR estimate include discrete items, consistent with more uncertainty and greater difficulty in understanding the tax environment when accounting standards require exceptions to the integral method. Taken together, our results suggest management interim ETR estimates are critical to the market’s understanding of tax expense.

Independent Analysts’ Estimates of Firm Value

We provide new evidence on the quality of independent analysts’ firm value estimates (i.e., price targets). Whereas prior literature generally finds that independent analysts’ research underperforms that of sell-side analysts using earlier sample periods, we show that, in a recent sample period, independent analysts’ research performs more favorably. That is, we find independent analysts’ price targets are less optimistic than investment-bank analysts’ forecasts with limited evidence of lower accuracy. Moreover, independent analysts’ price targets are less optimistic for firms with characteristics previously associated with overall analyst optimism, including higher stock price momentum and higher valuations. Our evaluation of the fundamental inputs from which independent analysts form their price targets suggests that less optimistic long-term growth forecasts could be responsible for the lower relative optimism in their price targets. Yet, even though independent analysts’ price targets provide less optimistic forecasts of firm value, the market reacts relatively less strongly to independent analysts’ price target revisions. These findings suggest that investors as well as those interested in extending empirical research into firm valuation can benefit from independent analysts’ price targets.

Managers’ Cost of Equity Capital Estimates: Empirical Evidence

Using actual practice data from U.S. corporate treasury executives, we provide initial evidence of managers’ internal estimates of their firms’ cost of equity capital (COEC) and extrapolate managers’ estimation practices to the broader population of public firms. Our study provides insights into the assumptions managers use in applying the capital asset pricing model (CAPM), the model that managers generally use to estimate their firms’ COEC according to prior research. We show that COEC estimates based on managers’ surveyed estimation practices are positively correlated with realized returns only in the pre-survey period, suggesting that managers set their COEC estimates in a backward-looking manner. Moreover, managers’ estimates are most correlated with estimates reverse-engineered following Easton, (2004) and Gode and Mohanram (2003).