Skip to main content
SpringerLink
Log in

Analysts’ choice of peer companies

  • Published:
Review of Accounting Studies Aims and scope Submit manuscript

Abstract

This is the first large-scale study to examine the peer companies used by sell-side equity analysts in their research reports. Using a unique hand-collected data set, we investigate the relation between peer valuation and peer choice by analysts. We find that analysts on average select peer companies with high valuations and that this effect varies systematically with analysts’ incentives and ability. Our evidence provides partial support for the idea that analysts choose peers strategically. We also find some support for the idea that the selection of peers with high valuations is used in part to justify optimistically skewed target prices and stock recommendations.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

Notes

  1. McNichols and O’Brien (1997) provide a further discussion of such potential self-selection biases.

  2. As mentioned in the introduction, although our findings are consistent with analysts behaving “strategically,” it is clearly difficult to rule out alternative explanations. We explore some alternative interpretations of our results in Sect. 5.4. Thus we suggest that our use of terms such as “bias” and “strategic” should be interpreted cautiously.

  3. Das et al. (1998) and Lim (2001) suggest that forecast optimism is used to increase access to management, especially in cases where the information asymmetry between management and investors is high.

  4. A large literature finds that equity analysts’ buy recommendations are (much) more prevalent than hold or sell recommendations (e.g., Barber et al. 2001; Malmendier and Shanthikumar 2007; Ke and Yu 2006; Barniv et al. 2009). Similarly, Brav and Lehavy (2003) find that analysts set target prices that are, on average, 28 percent higher than contemporaneous stock prices.

  5. Note that inferences are not affected by the inclusion of Sim_Multiple or other control variables.

  6. In our sample, 59 % of analyst reports are coded as Buy.

  7. In other words, our analyses are conducted at the analyst-report-firm-peer level. As a robustness test, we have conducted the analyses at the firm-peer level. No inferences are affected using this alternative specification.

  8. If we exclude the levels of the similarity variables, the coefficients on all but one of the similarity variables are positive and significant as expected (untabulated).

  9. There is no evidence of serious multicollinearity in our empirical tests. Specifically, the highest variance inflation factor is four.

  10. The number of observations is lower for Multiple Peer-E/P as the use of this multiple requires positive earnings.

  11. In untabulated analyses, we have also used sales to enterprise value and EBITDA to enterprise value as valuation proxies and find consistent results.

  12. The number of observations is smaller in these robustness tests as we cannot match all the analysts in our sample to I/B/E/S individual analysts/codes. The percent concordant and the pseudo R 2 are higher in these smaller samples and the estimated coefficients on the valuation measures are all negative and significant at the 1 % level.

  13. We obtain similar inferences when we limit the sample of report firms to those whose ex post performance variables can be measured for year t + 1.

References

  • Albuquerque, A. (2009). Peer firms in relative performance evaluation. Journal of Accounting and Economics, 48(1), 69–89.

    Article  Google Scholar 

  • Albuquerque, A., De Franco, G., & Verdi, R. (2013). Peer choice in CEO compensation. Journal of Financial Economics, 108(1), 160–181.

    Article  Google Scholar 

  • Alford, A. (1992). The effect of the set of comparable firms on the accuracy of the price-earnings valuation method. Journal of Accounting Research, 30(1), 94–108.

    Article  Google Scholar 

  • Baker, M., & Ruback, R. (1999). Estimating industry multiples. Working paper, Harvard University.

  • Barber, B., Lehavy, R., McNichols, M., & Trueman, B. (2001). Can investors profit from the prophets? Security analyst recommendations and stock returns. Journal of Finance, 56, 531–563.

    Article  Google Scholar 

  • Barber, B. M., & Lyon, J. D. (1996). Detecting abnormal operating performance: The empirical power and specification of test statistics. Journal of Financial Economics, 41, 359–399.

    Article  Google Scholar 

  • Barker, R. G. (1999). Survey and market-based evidence of industry-dependence in analysts’ preferences between the dividend yield and price-earnings ratio valuation models. Journal of Business Finance & Accounting, 26(3–4), 393–418.

    Article  Google Scholar 

  • Barniv, R., Hope, O.-K., Myring, M. J., & Thomas, W. B. (2009). Do analysts practice what they preach and should investors listen? Effects of recent regulations. The Accounting Review, 84(4), 1015–1039.

    Article  Google Scholar 

  • Barniv, R., Hope, O.-K., Myring, M. J., & Thomas, W. B. (2010). International evidence on analyst stock recommendations, valuations, and returns. Contemporary Accounting Research, 27(4), 1131–1167.

    Article  Google Scholar 

  • Bhojraj, S., & Lee, C. (2002). Who is my peer? A valuation-based approach to the selection of comparable firms. Journal of Accounting Research, 40(2), 407–439.

    Article  Google Scholar 

  • Bhojraj, S., Lee, C., & Oler, D. (2003). What’s my line? A comparison of industry classification schemes for capital market research. Journal of Accounting Research, 41(5), 745–774.

    Article  Google Scholar 

  • Block, S. B. (1999). A study of financial analysts: Practice and theory. Financial Analysts Journal, 55(4), 86–95.

    Article  Google Scholar 

  • Block, S. B. (2010). Methods of valuation: Myth vs. reality. Journal of Investing, 19(4), 7–14.

    Article  Google Scholar 

  • Boatsman, J., & Baskin, E. (1981). Asset valuation with incomplete markets. The Accounting Review LVI, 1, 38–53.

    Google Scholar 

  • Boni, L., & Womack, K. (2006). Analysts, industries, and price momentum. Journal of Financial and Quantitative Analysis, 41(1), 85–109.

    Article  Google Scholar 

  • Bradshaw, M. T. (2011). Analysts’ forecasts: What do we know after decades of work? Working paper, Boston College.

  • Bradshaw, M. T., Miller, G., & Serafeim, G. (2010). Accounting method heterogeneity and analysts’ forecasts. Working paper, Boston College, University of Michigan, and Harvard Business School.

  • Brav, A., & Lehavy, R. (2003). An empirical analysis of analysts’ target prices: Short-term informativeness and long-term dynamics. Journal of Finance, 58(5), 1933–1967.

    Article  Google Scholar 

  • Chan, L., Lakonishok, J., & Swaminathan, B. (2007). Industry classifications and return comovement. Financial Analysts Journal, 63(6), 56–70.

    Article  Google Scholar 

  • Clarke, J., Khorana, A., Patel, A., & Rau, P. R. (2007). The impact of all-star analyst job changes on their coverage choices and investment banking deal flow. Journal of Financial Economics, 84, 713–737.

    Article  Google Scholar 

  • Damodaran, A. (2009). The dark side of valuation: Valuing young, distressed, and complex businesses (2nd ed.). Upper Saddle River: Pearson Education.

    Google Scholar 

  • Das, S., Levine, C., & Sivaramakrishnan, S. (1998). Earnings predictability and bias in analysts’ earnings forecasts. The Accounting Review, 73(2), 277–294.

    Google Scholar 

  • De Franco, G., Gavious, I., Jin, J., & Richardson, G. (2011a). Do private company targets that hire Big4 auditors receive higher proceeds? Contemporary Accounting Research, 28(1), 215–262.

    Article  Google Scholar 

  • De Franco, G., Hope, O.-K., Vyas, D., & Zhou, Y. (2014). Analyst report readability. Contemporary Accounting Research. doi:10.1111/1911-3846.12062.

  • De Franco, G., Kothari, S. P., & Verdi, R. (2011b). The benefits of financial statement comparability. Journal of Accounting Research, 49(4), 895–931.

    Article  Google Scholar 

  • Dechow, P., Hutton, A., & Sloan, R. (2000). The relation between analysts’ forecasts of long-term earnings growth and stock price performance following equity offerings. Contemporary Accounting Research, 17(1), 1–32.

    Article  Google Scholar 

  • Dugar, A., & Nathan, S. (1995). The effects of investment banking relationships on financial analysts’ earnings forecasts and investment recommendations. Contemporary Accounting Research, 11(1), 131–160.

    Article  Google Scholar 

  • Ecker, F., Francis, J., Olsson, P., & Schipper, K. (2013). Estimation sample selection for discretionary accruals models. Journal of Accounting and Economics, 56(2), 190–211.

    Article  Google Scholar 

  • Ertimur, Y., Sunder, J., & Sunder, S. (2007). Measure for measure: The relation between forecast accuracy and recommendation profitability of analysts. Journal of Accounting Research, 45(3), 567–606.

    Article  Google Scholar 

  • Gleason, C., & Lee, C. (2003). Analyst forecast revisions and market price discovery. The Accounting Review, 78(1), 193–225.

    Article  Google Scholar 

  • Groysberg, B., Healy, P., & Maber, D. (2011). What drives financial analyst compensation? Financial Analysts Journal, 67(4), 18–29.

    Article  Google Scholar 

  • Guan, Y., Lu, H., & Wong, F. (2012). Conflict-of-interest reforms and analysts’ research biases. Journal of Accounting, Auditing, and Finance, 27(4), 443–470.

    Article  Google Scholar 

  • Healy, P. M., & Palepu, K. G. (2007). Business analysis and valuation: Using financial statements (4th ed.). Mason, Ohio: Thomson Southwestern.

    Google Scholar 

  • Heflin, F., Subramanyam, K. R., & Zhang, Y. (2003). Regulation FD and the financial information environment: Early evidence. The Accounting Review, 78(1), 1–37.

    Article  Google Scholar 

  • Hoitash, R., Kogan, A., & Vasarhelyi, M. (2006). Peer-based approach for analytical procedures. Auditing: A Journal of Practice and Theory, 25(2), 53–84.

    Article  Google Scholar 

  • Imam, S., Barker, R., & Clubb, C. (2008). The use of valuation models by UK investment analysts. European Accounting Review, 17(3), 503–535.

    Article  Google Scholar 

  • Institutional Investor. (2010 October). The 2010 All-America Research Team (p 52).

  • Kadan, O., Madureira, L., Wang, R., & Zach, T. (2012). Analysts’ industry expertise. Journal of Accounting and Economics, 54(2–3), 95–120.

    Article  Google Scholar 

  • Ke, B., & Yu, Y. (2006). The effect of issuing biased earnings forecasts on analysts’ access to management and survival. Journal of Accounting Research, 44, 965–999.

    Article  Google Scholar 

  • Kim, M., & Ritter, J. (1999). Valuing IPOs. Journal of Financial Economics, 53(3), 409–437.

    Article  Google Scholar 

  • Koller, T., Goedhart, M., & Wessels, D. (2005). Valuation: Measuring and managing the value of companies. Hoboken, NJ: McKinsey & Company, Wiley.

    Google Scholar 

  • Lim, T. (2001). Rationality and analysts’ bias. Journal of Finance, 56(1), 369–385.

    Article  Google Scholar 

  • Lin, H. W., & McNichols, M. F. (1998). Underwriting relationships, analysts’ earnings forecasts and investment recommendations. Journal of Accounting and Economics, 25(1), 101–127.

    Article  Google Scholar 

  • Litov, L., Moreton, P., & Zenger, T. (2012). Corporate strategy, analyst coverage, and the uniqueness paradox. Management Science, 58(10), 1797–1815.

    Article  Google Scholar 

  • Liu, J., Nissim, D., & Thomas, J. (2002). Equity valuation using multiples. Journal of Accounting Research, 40(1), 135–172.

    Article  Google Scholar 

  • Liu, J., Nissim, D., & Thomas, J. (2007). Is cash flow king in valuations? Financial Analysts’ Journal, 63(2), 56–68.

    Article  Google Scholar 

  • Malmendier, U., & Shanthikumar, D. (2007). Are small investors naive about incentives? Journal of Financial Economics, 85, 457–489.

    Article  Google Scholar 

  • McNichols, M., & O’Brien, P. (1997). Self-selection and analyst coverage. Journal of Accounting Research, 35, 167–199.

    Article  Google Scholar 

  • Michaely, R., & Womack, K. (1999). Conflict of interest and the credibility of underwrite analyst recommendations. Review of Financial Studies, 12(4), 653–686.

    Article  Google Scholar 

  • Michaely, R., & Womack, K. (2005). Brokerage recommendations, Stylized characteristics, market responses, and biases. In R. H. Thaler (Ed.), Advances in behavioral finance II (pp. 389–422). Princeton, New Jersey: Princeton University Press.

    Google Scholar 

  • Minutti-Meza, M. (2013). Does using information from peer-firms improve account-level expectation models? Journal of Accounting Research, 51(4), 779–817.

    Google Scholar 

  • Roosenboom, P. (2007). How do underwriters value initial public offerings? An empirical analysis of the French IPO market. Contemporary Accounting Research, 24(4), 1217–1243.

    Article  Google Scholar 

  • Schipper, K. (1991). Commentary on analysts’ forecasts. Accounting Horizons, 5(4), 105–121.

    Google Scholar 

  • Stickel, S. (1990). Predicting individual analyst earnings forecasts. Journal of Accounting Research, 28(2), 409–417.

    Article  Google Scholar 

  • Stickel, S. (1992). Reputation and performance among security analysts. Journal of Finance, 47(5), 1811–1836.

    Article  Google Scholar 

  • Stickney, C., Brown, P., & Wahlen, J. (2007). Financial reporting, financial statement analysis, and valuation: A strategic perspective (6th ed.). Mason, Ohio: Thomson/South-Western.

    Google Scholar 

Download references

Acknowledgments

We thank Brian Bratten, Larry Brown, Cristi Gleason, Artur Hugon, Marcus Kirk, Miguel Minutti-Meza, Partha Mohanram, Rodrigo Verdi, Richard Willis, Kent Womack, Wuyang Zhao, Yibin Zhou, and Youli Zou as well as workshop participants at University of Notre Dame, University of Toronto, University of Florida, Norwegian School of Economics, Arizona State University, Purdue University, University of Illinois at Chicago, University of Iowa, Hong Kong Polytechnic University, and the AAA Annual (Washington DC), FARS (San Diego), and JCAE (Hong Kong) meetings for comments and suggestions. We thank Jonathan Chen, Steve El-Hage, Wendy Gu, Megan Jiang, Matthew Literovich, Jeffrey Ma, Sunyoung Par, Philip Rabenok, Tian Shen, Menghan Yan, and Jimmy Zhu for their excellent research assistance. We thank Yuyan Guan, Hai Lu, and Franco Wong for data on investment banking affiliations. We gratefully acknowledge the financial support of the Social Sciences and Humanities Research Council of Canada, the Rotman School of Management, and the Mendoza College of Business. Hope further acknowledges the financial support of the Deloitte Professorship.

Author information

Authors and Affiliations

  1. Rotman School of Management, University of Toronto, Toronto, Canada

    Gus De Franco & Ole-Kristian Hope

  2. Mendoza College of Business, University of Notre Dame, Notre Dame, IN, USA

    Stephannie Larocque

Authors
  1. Gus De Franco
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Ole-Kristian Hope
    View author publications

    You can also search for this author in PubMed Google Scholar

  3. Stephannie Larocque
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Stephannie Larocque.

Appendix

Appendix

See Table 7.

Table 7 Variable definitions
Full size table

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

De Franco, G., Hope, OK. & Larocque, S. Analysts’ choice of peer companies. Rev Account Stud 20, 82–109 (2015). https://doi.org/10.1007/s11142-014-9294-7

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11142-014-9294-7

Keywords

JEL Classification

Search

Navigation