Abstract

Acknowledgements
List of Tables/Figures
Table of Contents
1. Introduction
 2. Prior Literature

Financial analysts process plenty of internal and external information

surrounding companies they review and thus provide a crucial role in the
capital markets. Reaching a level of understanding regarding the factors
influencing forecast accuracy is important for accounting researchers that use
analysts' forecasts as a proxy for the capital markets' expectation of earnings.
Analysts play a crucial intermediary role in terms of market efficiency by
providing financial information that supports transactions. The financial
reports itself won’t be enough to make earnings forecasts to understand the
business condition of a firm thus a wider and more holistic approach involving
analysis of several issues. Companies and general public take their stock
related decisions based on analysts’ analyses making the accuracy of the
analyst analysis a very important concern for the companies and general
public.

Sinha et al (1997) criticised O’Brien (1987) for falsely concluding in his study
that there were “no differences in analysts’ earnings forecast accuracy” as
there were no “control of differences in the recency of forecasts issued.”
Moreover, Lawrence D Browne (2001) also asserted that “analyst ratings are
important to those that believe past accuracy portends future forecast
accuracy.” An analyst’s prior ability (measured via prior forecast accuracy) to
forecast a specific firm’s earnings is a good indicator for the accuracy of her
earnings forecasts for that firm.

Having firm-specific experience implies a better understanding of the firm in

terms of operations and management therefore creating opportunities for
analysts to build deeper working relationships with members of the firm,
which could provide the analyst with inside information. Moreover, an analysts
firm-specific skill & knowledge won’t only improve accuracy of forecasts, but
increase firm value.

It is inevitable that particular determinants such as experience holds

predictability in regard to forecast accuracy. Firm-specific experience as
Clement (1999) indicated, is positively correlated with an analysts’ forecast
accuracy of EPS. Likewise, furthering his study led to further findings showing
how “analysts forecast accuracy improves faster per unit of firm-specific
experience than other aspects.” Hence, he highlighted that analysts with more
firm-specific experience is more able to survive in labour markets by
evidencing that 5 years of firm-specific experience produced a 3.8% higher
earning forecast accuracy in comparison to having 1 year of firm-specific
experience.
Mikhail et al (1997) indicated an analyst that follows the same firm for several
years would gain firm-specific knowledge and potentially inside information
too. Using the “number of quarters when an earnings forecast is issued by the
analyst”. He showed that analyst performed better the greater the knowledge
they possess (controlled variables e.g. analyst age & 4th quarter effect).
Though it is not explicitly stated how improvement occurs, Clement’s (1999)
study does.

Furthermore, Jacob et al (1999) also highlighted how the extent of an analyst’s

firm-specific skill can influence forecast accuracy positively. It was found that
the forecast accuracy increases with the effort devoted to the firm. It was
found that the absolute error of forecasts declined as firm-specific experience
increased. An analysts’ “firm-specific expertise should be both negatively
related to forecast error and positively related to profitable growth
opportunities.” The expected relationship between the percentage of
companies followed by the analyst which are in the same industry are
expected to be positively related to forecast accuracy. In conclusion, analyst
forecast accuracy increases provided the analysis is kept limited to a specific
industry and the brokerage size. The forecast accuracy also improves if the
forecast is made maintaining a certain interval.
 3. RESEARCH DESIGN

Hypothesis

Based on previous studies, we can establish that analysts’ forecast accuracy is

influenced by several factors. It is crucial that these independent variables are
assessed in order to determine the most influential factor given the
importance the role of an analyst has in the financial market. Different forms
of experience such as general, firm-specific & industry-specific tend to
influence forecast accuracy. This dissertation will focus on the level of firm-
specific experience due to the controllability and the numerous studies
surrounding this factor and its implications on accuracy.

H1: Firm-specific experience is positively correlated with analysts' earnings

forecasts accuracy for US financial services firms (commercial banks) during
the period of 2009 to 2012 (post financial crisis).

The variables of interest here are DV = Analyst forecast accuracy & IV = Firm-
specific experience.
Forecast accuracy (DV) can be measured by applying Clement’s (1999)
‘Proportional Mean Absolute Forecast Error’ (PMAFE) formula
𝐏𝐌𝐀𝐅𝐄𝐢𝐣𝐭=(𝐀𝐅𝐄𝐢𝐣𝐭− 𝐀𝐅𝐄𝐣𝐭̅)/𝐀𝐅𝐄𝐣𝐭̅[= 𝑫𝑨𝑭𝑬𝒊𝒋𝒕 / 𝑨𝑭𝑬𝒋𝒕̅] . This measure
accounts for time-series and cross sectional differences where the individual
analyst’s forecast error that year minus the mean forecast error of all analysts
following the specific company that year scaled by the mean of forecast errors
of all analysts following the firm in the particular year.
Independent variables used will be derived from past studies such as Clement
(1999).
NOTATION:
𝑭𝑬𝑿𝑷𝒊𝒋 = Measures the analyst's firm-specific experience. i.e. the number of
years an analyst ‘i’ produced earnings forecasts for their financial firm ‘j’.

Dependent variables used will also come from the Clement (1999) case study.
NOTATION:
𝐀𝐅𝐄𝐢𝐣𝐭 = absolute difference between forecasted EPS by analyst ‘i’ and the
actual EPS of firm ‘j’ in year ’t’
𝐀𝐅𝐄𝐣𝐭̅ = Represents the absolute forecast error of analysts as a whole for
financial firms j, at time t.
𝑫𝑨𝑭𝑬𝒊𝒋𝒕 = 𝐀𝐅𝐄𝐢𝐣𝐭 - 𝐀𝐅𝐄𝐣𝐭̅

PMAFE is a good measure for several reasons, one of which, is that it controls
firm-year effects. Clement (1999) demonstrated how there were greater
deviations in 𝑫𝑨𝑭𝑬𝒊𝒋𝒕 amongst firms with higher EPS figures, which therefore
creates bias. Heteroskedasticity suggests variability is dependent on the
constant and to an extent, changes in the original independent variable which
is an issue. According to Clement (1999) greater unpredictability occur in
forecast errors for larger firms. So 𝐴𝐹𝐸𝑗𝑡̅ reduces heteroskedasticity by
reducing 𝐷𝐴𝐹𝐸𝑖𝑗𝑡 or by deflating AFEijt - AFEjt by AFEjt. Nonetheless, this
highlights how a smaller/negative PMAFE figure would suggest a better
performance (higher than average) in terms of forecast accuracy, vice-versa.
This is because accuracy and forecast error are conversely related.
Univariate Analysis……

This analysis will be used to establish and describe data regarding the firm-
specific experience and its effect on forecast accuracy. This should allow us to
determine whether a simple relationship exists between the two variables. For
consistency with the PMAFE measure, independent variables ie. other types of
experience such as industry are to be firm-year mean adjusted. The sample of
analysts will be split in to a firm-specific experienced group and a less firm-
specific experience group where average forecast accuracy will be measured.
There isn’t a strict method in classifying an analyst as experienced or
inexperienced thus the sample can be split into analysts with 0-5 years firm-
specific experience and those with more than 5 years (based on even division
of firm-specific experience years). It is also important that there are equal
sample numbers in both groups before performing the t-test in order to
determine any significance in value between the groups.

Multivariate Analysis…

𝐏𝐌𝐀𝐅𝐄𝐢𝐣𝐭= 𝜷𝟏𝑫𝑮𝑬𝑿𝑷𝒊𝒋+ 𝜷𝟐𝑫𝑭𝑬𝑿𝑷𝒊𝒋+ 𝜷𝟑𝑫𝑰𝑵𝑬𝑿𝑷𝒊𝒋+ 𝜷𝟒𝑫𝑵𝑻𝑶𝑷𝟏𝟎𝒊𝒋𝒕+

𝜺𝒊𝒋𝒕
(-) (-) (-) (-)
The 3 other independent variables will be other forms of analysts experience
e.g. industry experience, which allows us to derive this regression model using
Clement’s (1999) measure of forecast error therefore allowing the hypothesis
to be tested. The prefix D for each independent variable means that they are
all mean adjusted, hence, the reason why no constant term is included.
Nonetheless, a positive PMAFE figure would indicate forecast error of specific
analyst “i” for the company “j” would have exceeded the mean value during
year “t”. Each independent variable is also denoted with a negative sign
because it is expected that forecast error falls as experience improves ie. betas
have negative coefficients and low forecast errors represent higher levels of
accuracy. Using this model, the regression results obtained from the cross-
sectional analysis will be compared.
 4. Data & Sample
The data collected for this study will focus on the Commercial Banking Industry (SIC code
6029), which consists of financial institutions that which do not operate under Federal or
State charter. I select a sample of 45 companies from this specific industry in USA for 3 after
the financial crisis (2009-2012). I then collect the data for EPS forecasts by analysts and
actual EPS figures Institutional Broker Estimate System (I/B/E/S). Both general and firm
specific forecasting experience are calculated respectively as the total number of years that
analyst i appeared in I/B/E/S (Gexpi) and the total number of years since analyst i first
provided earnings forecast for firm j (Fexpij).