“If managers want analysts to be optimistic (as they once did) analysts will be optimistic.”

The state of the art in academia was that sell-side analysts’ earnings forecasts tended to be optimistic (i.e., they are high compared to the earnings number that managers subsequently reported). The view by practitioners was that firms’ managers reported earnings that just met or slightly beat analysts’ earnings estimates. In other words, the practitioner view was that analysts’ earnings forecasts tended to be pessimistic. The practitioner view was borne out almost daily in the late 1990s by the financial press which showed that firms reported earnings that just met or slightly beat analysts’ earnings estimates. I show that analysts’ earnings forecasts used to be optimistic (consistent with the academic view) but that in recent years, analysts’ earnings forecasts have become pessimistic (consistent with the practitioner view). Another reason for it being highly cited is my use of pictures in lieu of numbers (i.e., figures rather than tables).

It reconciled the academic view (which was based on old data) with the practitioner view (which would be the correct academic view if it was based on more recent data).

It shifted the state of the art in the academic literature from a view that analysts’ forecasts of firms’ earnings numbers are optimistic to a view that they are instead pessimistic.

In my contact with academics and practitioners, and my perusal of the financial press, I recognized that the academic and the practitioner views of analyst behavior are diametrically opposed to each other. Academics argued that in order to please managers, analysts tended to be optimistic. A primary reason given for analyst optimism is that managers wanted to boost their stock prices by having analysts make high earnings forecasts. Practitioners told me that in order to please managers, analysts tended to be pessimistic. A primary reason given for analyst pessimism is to avoid lawsuits instituted when firms reported earnings that are below what the analysts were forecasting. I thought that the practitioners were correct and that the academic view was based on old data that no longer pertained to the real world.

Analysts act in their own best interests. It is in the best interests of analysts to please managers so as to obtain underwriting business and to obtain from them information useful in making their earnings forecasts and stock recommendations. If managers want analysts to be optimistic (as they once did) analysts will be optimistic. If managers want analysts to be pessimistic (as they have for at least the past decade), analysts will be pessimistic.