The Association between the Legal and Financial Reporting Environments and Forecast Performance of Individual Analysts*

Abstract

We test the ability of analyst characteristics to explain relative forecast accuracy across legal origins (common law versus civil law). Common‐law countries generally have more effective corporate governance mechanisms, including stronger investor protection laws and inputs provided through higher‐quality financial reporting systems. In this type of environment, we predict that analysts with superior ability and resources in common‐law countries will more consistently outperform their peers because appropriate market‐based incentives exist. In civil‐law countries, where the demand for earnings information is reduced because of weaker corporate governance mechanisms and lower‐quality financial reporting, we predict that analysts with superior ability will less consistently provide superior forecasts. Results are consistent with our expectations and suggest an association between legal and financial reporting environments and analysts' forecast behavior.

The Regulatory Effect on the Performance of Financial Analysts: Time Series from Two Different Legal Systems

“…For example, Barniv et al [5], Basu et al [32], Ashbaugh et al [6], and Hope [7,8] offer evidence that the accuracy of analysts' earnings forecasts varies around the world and that such variation relates positively to disclosure practices and investor protection. Barniv et al [5] found that analysts in commonlaw countries outperform their peers in civil-law countries and therefore suggest an association between legal and financial reporting environments and analysts´ forecast behaviour. Analysts may also have greater incentives to forecast accurately in well-developed capital markets (strong shareholder protection countries), where investors may exhibit greater demand for earnings forecasts [5].…”

“…Barniv et al [5] found that analysts in commonlaw countries outperform their peers in civil-law countries and therefore suggest an association between legal and financial reporting environments and analysts´ forecast behaviour. Analysts may also have greater incentives to forecast accurately in well-developed capital markets (strong shareholder protection countries), where investors may exhibit greater demand for earnings forecasts [5]. Chang et al [4] studied the extent and accuracy of analysts' activity across 47 countries around the world and found forecast accuracy to be lower in civil-law countries than in common-law countries.…”

“…A consequence of this conception is market participants regard inefficient information processing by analysts as strong evidence of overall market inefficiency. This has led to a stream of research focusing on analysts and the importance of the regulatory settings when it comes to analysts' role, behavior and performance [4][5][6][7][8][9][10][11][12]. Several studies have used the level of legal protection of shareholders as a variable, and a number of these have shown that it has an impact on analysts' performance.…”

“…Many researchers suggest that analysts in common-law countries play a more important role and perform better than analysts in civillaw countries. Their arguments are based on studies analyzing the relationship between different aspects of analysts' performance and a country's level of legal protection [4,5,14,15].…”

Analysts’ Forecast Accuracy in Germany: The Effect of Different Accounting Principles and Changes of Accounting Principles

“…This allows us to control effectively for differences in institutional factors, like regulatory requirements or the enforcement system. Such factors have been shown to vary across countries and to be important determinants of analysts' forecast quality (Hope 2003a;Hope 2003b;Hope 2004;Barniv, Myring, and Thomas 2005 (2007) provide evidence for the high degree of differences between IAS/IFRS and German GAAP.…”