Analyst incentives, forecast biases, and stock returns

Prior studies suggest that analysts have incentives to bias their earnings forecasts, especially for longer horizon forecasts. We use the difference between analysts’ two-year and one-year-ahead earnings forecasts (FECH) as a measure of analysts’ biased incentives. We find that high FECH firms underperform low FECH firms by 0.85% in the following month and the underperformance persists up to at least six months. In addition, the negative FECH-return relation is more pronounced when analyst incentives to bias forecasts are higher. Finally, high FECH firms have significantly negative future forecast errors and forecast revisions when their incentives to bias forecasts are high. Overall, our study indicates that analyst incentives to bias forecasts have implications for stock market efficiency.