How to Measure Analyst Forecast Effort

Abstract

We introduce a new way to measure the forecast effort that analysts devote to their earnings forecasts by measuring the analyst's general effort for all covered firms. While the commonly applied effort measure is based on analyst behaviour for one firm, our measure considers analyst behaviour for all covered firms. Our general effort measure captures additional information about analyst effort and thus can identify accurate forecasts. We emphasise the importance of investigating analyst behaviour in a larger context and argue that analysts who generally devote substantial forecast effort are also likely to devote substantial effort to a specific firm, even if this effort might not be captured by a firm-specific measure. Empirical results reveal that analysts who devote higher general forecast effort issue more accurate forecasts. Additional investigations show that analysts' career prospects improve with higher general forecast effort. Our measure improves on existing methods as it has higher explanatory power regarding differences in forecast accuracy than the commonly applied effort measure. Additionally, it can address research questions that cannot be examined with a firm-specific measure. It provides a simple but comprehensive way to identify accurate analysts.

Underlying risk preferences and analyst risk‐taking behavior

“…To explain analyst decision making, prior research has examined characteristics of analysts' skills such as experience (Hong and Kubik 2003;Clement 1999;Clement and Tse 2005;Shon and Young 2011;Mikhail et al 1997); effort (Klettke et al 2015); task complexity (Clement 1999); analyst incentives (Shon and Young 2011); communication with management (Chen and Matsumoto 2006;Green et al 2014;Ke and Yu 2006); brokerage house characteristics, such as brokerage size (Clement 1999;Clement and Tse 2005); firm characteristics, such as operating performance (Shon and Young 2011) and intangibles (Amir et al 2003); analyst following (Alford and Berger 1999;Hong et al 2000); corporate international diversification (Duru and Reeb 2002); annual report readability (Lehavy et al 2011) or verifiability (Bozzolan et al 2009); and audit quality (Behn et al 2008).…”