Financial Analyst Forecasts: Does the Media Matter?

CUHK research finds that financial analysts in countries with stronger media competition tend to form more accurate, less biased and less dispersed forecasts

By Jaymee Ng, Principal Writer, China Business Knowledge@CUHK

Financial analysts provide a crucial service for companies and investors. They play an important role in the capital market by collecting, generating and distributing information. But why are the forecasts of some analysts more accurate than others? How can analysts improve their quality? A recent research study reveals that the news media play an important role in enhancing the quality of financial analysts’ forecasts.

The research – The Effect of Media Competition on Analyst Forecast Properties: Cross-Country Evidence, is a joint effort by Cao Ying, Associate Professor of Accounting at The Chinese University of Hong Kong Business School, Prof. Sami Keskek at Florida State University, Prof. Linda Myers at the University of Tennessee, Knoxville and Prof. Albert Tsang at York University. The researchers examined 113,436 analyst forecasts for 19,490 unique firms in 32 countries from 2000 to 2012. Their findings suggest that the media and financial analysts have a complementing relationship because the media provide a wide range of information that is crucial to the latter group.

“High quality media is indispensable for financial analysts, providing them with more and better information that lead to better quality forecasts.”

Prof. Cao Ying.

“We found that analysts benefit from fierce competition in a country’s media industry,” Prof. Cao says. “Our results suggest that strong media competition improves the information environment, which in turn increases the quality of analysts’ forecasts and benefits the investors who rely on these forecasts.

Media Competition and Information Quality

Prof. Cao explains how media competition enhances the quality of information available to financial analysts. For example, high-quality news media provide information not only about company transactions, corporate leaders and their operations but also about competitors and industries, as well as developments in the macroeconomy and the implications on firm operations.

Interestingly, the researchers found that countries with high media freedom or media penetration, which refers to the number of people with access to newspapers and other media sources, do not necessarily have high media competition. For example, Denmark, Singapore, Austria and Germany all have high media penetration but relatively low media competition. On the other hand, Brazil and India have low media penetration but relatively high media competition.

The research team examined how media competition influences analyst forecasts in three aspects: forecast error, forecast bias and forecast dispersion. Forecast error is measured by the difference between actual and the mean analyst earnings per share (EPS) forecast. Forecast bias indicates whether the analyst was too optimistic or pessimistic when making the forecasts. Finally, forecast dispersion measures how diverse analyst opinions are about the firm’s future earnings.

According to the study, the forecast error is 28.6 percent lower in countries with high media competition than that in countries with low media competition. Forecast bias and forecast dispersion are 29.1 percent and 25 percent lower, respectively. After controlling other factors that influence analyst forecasts, a one standard deviation increase in media competition can reduce forecast error, forecast bias and forecast dispersion by 12.3 percent, 19.1 percent and a 4.2 percent, respectively.

When Does Media Competition Matter Most?

The study found that the positive effects of media competition on analyst forecasts are more pronounced when alternative channels for analysts to receive information are limited or of poor quality. For instance, firms’ voluntary disclosures are an important information source, and greater institutional ownership of a firm’s stock usually enhances voluntary disclosure. Therefore, when institutions hold less of a firm’s stock there tends to be less voluntary information disclosed by the firm.

On the other hand, firms followed by many analysts or by analysts from large brokerage houses are under pressure to disclose more information. According to the results, the effect of media competition on analysts’ forecasts is stronger when firms have lower institutional ownership or are followed by fewer analysts, or by analysts from smaller brokerage houses.

“Competition is what makes the media thrive and improve. High quality media is indispensable for financial analysts, providing them with more and better information that lead to better quality forecasts,” Prof. Cao says.

“Our research findings have important implications,” Prof. Cao explains. “For media regulators, they need to understand the role of media competition in capital market development. For investors and financial analysts, they should now see media competition as a crucial factor that affects the quality of the information that they obtain, which in turn affects their judgements and investment decisions.”