Analyst information acquisition and the relative informativeness of analyst forecasts and managed earnings

Mixed empirical evidence exists on whether equity analyst forecasts complement (‘interpretation role’) or rather substitute for (‘information role’) the informativeness of corporate earnings. This paper develops a theoretical model in which an analyst acquires costly information to forecast the fundamental information contained in a subsequently released and strategically manipulated earnings announcement. The manager is assumed to manipulate earnings such that his objectives – an uncertain price interest and meeting-or-beating the analyst forecast incentives – are optimized. The model shows that the manager’s incentives are the source of the two roles of the analyst information in the valuation of earnings. In a theoretical regression of share price on earnings and the analyst forecast, it can be shown that a positive forecast response coefficient, and thus the dominance of the information role of analyst forecasts, is only obtained if the analyst’s information acquisition costs are sufficiently low.