Measure for Measure: The Relation between Forecast Accuracy and Recommendation Profitability of Analysts
ABSTRACTWe examine the contemporaneous relation; between earnings forecast accuracy and recommendation profitability to; assess the effectiveness with which analysts translate forecasts into; profitable recommendations. We find that, after controlling for expertise,; more accurate analysts make more profitable recommendations, albeit only; for firms with value-relevant earnings. Next, we show that conflicts of; interest from investment banking activities affect the relation between; accuracy and profitability. In the case of buy recommendations, more; accurate forecasts are associated with more profitable recommendations; only for the nonconflicted analysts. For hold recommendations, higher; levels of accuracy are associated with higher levels of profitability for; conflicted analysts, provided these recommendations are treated as sells.; Finally, we find that regulatory reforms aimed at mitigating analyst; conflicts of interest appear to have improved the relation between; accuracy and profitability. Specifically, the integrity of buy and hold; recommendations has improved and the change is more pronounced for; analysts expected to be most conflicted. Copyright University of Chicago on behalf of the Institute of Professional Accounting, 2007.