Workshop Series: Philip Shane
This paper examines the efficiency with which financial analysts' earnings forecasts and returns on investments in equity securities respond to cash and accrual components of reported earnings. Controlling for the market response when examining analyst response and vice versa provides insights not apparent from the usual procedure that examines analyst and market efficiency without these controls. In particular, we find that controlling for investor overreaction, financial analysts' forecasts generally underreact to earnings; whereas controlling for analyst underreaction, investors generally overreact to earnings. Controlling for market overreaction, we find that analyst underreaction to free cash flow drives the general analyst underreaction to earnings, and we find strong analyst undereraction to all three components of free cash flow: the change in financial assets, net distributions to debt holders and net distributions to stockholders. Controlling for analyst underreaction, we find market overreaction to both free cash flow and accrual earnings components. Overreaction to the change in financial assets and, to a lesser extent, distributions to debt holders drives the market overreaction to the free cash flow component of earnings, and overreaction to changes in asset turnover and sales growth drives the overreaction to the accrual component of earnings. These results provide new insights into investor and analyst behavior after controlling for the strong positive relation between analyst forecast revisions and returns.
Phil Shane is a Professor at the McIntire School of Commerce at the University of Virginia. Professor Shane's research interests include the economics of financial reporting, financial statement analysis, incentives and efficiency of financial analysts as intermediaries in the interpretation of accounting information for resource allocation in capital markets, market efficiency with respect to accounting information, and accounting for the sustainability of corporate business practices. His current research focuses on market efficiency with respect to differences in the information contained in accrual and cash components of earnings, measuring and evaluating the efficiency of the market's response to earnings news, and the impact of earnings management constraints on managers' incentives to provide information about future earnings. Professor Shane currently teaches the core financial accounting course in the M.S. in Commerce Program and the second half of intermediate financial reporting for undergraduate Commerce students. His research has been published in journals such as The Accounting Review; Journal of Accounting Research; Journal of Accounting and Economics; Contemporary Accounting Research; Decision Sciences; Journal of Accounting, Auditing & Finance; and International Journal of Forecasting. He served as president of the Financial Accounting and Reporting Section of the American Accounting Association (2007-2008), and he held the Academic Research Fellow position at the Financial Accounting Standards Board (2010-2011). Before coming to the McIntire School of Commerce, he held faculty positions at the Universities of Kansas, Montana, Arizona, and Colorado and at The Pennsylvania State University. He currently holds a 10 percent appointment as a Professor in the Auckland Business School at the University of Auckland. He is a CPA (inactive) and had experience with PricewaterhouseCoopers before his academic career.