Economic Incentives for Analysts Play Role in Determining Street Earnings

Nov 06, 2008

Even though investors use street earnings as a key valuation measure, little is known about analysts’ rationale when determining street earnings. Street earnings are an adapted version of earnings based on modifications that are decided on a firm-by-firm basis and reflect analysts’ decisions to include or exclude certain expenses. In a new study, a University of Missouri researcher found that analysts’ self-interests often influence the value of street earnings, which makes street earnings less useful for predicting future earnings of high-growth stocks.

“Decisions when calculating street earnings are quite subjective,” said David B. Farber, assistant professor of accountancy in the MU Robert J. Trulaske, Sr. College of Business. “We found that analysts’ economic incentives are associated with the adjustments made when deciding street earnings. When analysts are more optimistic toward glamour stocks, more trade and investment banking business is generated.”

Using detailed data on analysts’ inclusion and exclusion decisions on nonrecurring expense items, Farber found that street earnings for glamour stocks (stocks that appear to have high-growth potential) were more upwardly biased than street earnings for values stocks (stocks that tend to trade at a low price relative to their fundamentals). Expenses for glamour stocks that should be included in street earnings were, instead, excluded.

“Analysts are more likely to exclude expense items when determining street earnings for glamour stocks than for value stocks,” Farber said. “Although we argue that analysts have an economic incentive to be biased toward street earnings of glamour stocks, we cannot establish whether the observed bias is intentional. Also, several agents play roles in the determination of street earnings, so we cannot attribute all of the bias to analysts.”

The study, “Analysts’ Incentives and Street Earnings,” has been accepted for publication in the Journal of Accounting Research and is co-authored by Bok Baik of Seoul National University and Kathy Petroni of Michigan State University.

Provided by University of Missouri

Explore further: Research band at Karolinska tuck Dylan gems into papers

add to favorites email to friend print save as pdf

Related Stories

Aetna 2Q profit rises 2.4 percent

Jul 29, 2014

Aetna's second-quarter profit climbed more than 2 percent, as gains from an acquisition helped the health insurer beat analyst expectations and raise its 2014 earnings forecast again.

Facebook 2Q earnings, revenue soar (Update)

Jul 23, 2014

(AP)—Facebook is on a roll. The world's largest online social network posted sharply higher earnings on Wednesday as revenue from mobile advertising continued to grow, and more people used it, more often.

Recommended for you

Research band at Karolinska tuck Dylan gems into papers

13 hours ago

(Phys.org) —A 17-year old bet among scientists at the Karolinska Institute has been a wager that whoever wrote the most articles with Dylan quotes before they retired would get a free lunch. Results included ...

A simulation game to help people prep for court

Sep 25, 2014

Preparing for court and appearing before a judge can be a daunting experience, particularly for people who are representing themselves because they can't afford a lawyer or simply don't know all the ropes ...

When finding 'nothing' means something

Sep 25, 2014

Scientists usually communicate their latest findings by publishing results as scientific papers in journals that are almost always accessible online (albeit often at a price), ensuring fast sharing of latest ...

User comments : 0