Empirical Research in Financial Reporting: AIM 7314.

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(Empirical Accounting Research on Information Intermediaries)

Meetings: Tuesday 2:30 – 5:15 PM in room 4.418

Instructor: Stanimir Markov

Office: SOM 4.431
Ph: 972-883-4426
Fax: 972-883-6811
E-Mail: stan.markov@utdallas.edu
Office Hours: by appointment

Course description

The course surveys empirical research on information intermediaries: sell-side analysts, credit rating
agencies, and the financial press. We will discuss classic papers and recent work appearing in accounting
or finance journals. Topics include the rational expectations and market efficiency hypotheses, deviations
from the rationality ideal, types of information produced and its market consequences. Students will be
asked to execute a data analysis project that replicates prior results, and produce a research proposal on a
topic related to information intermediaries, or more generally to the production and dissemination of
information in capital markets.

To make the most of the course students should have a basic knowledge of (1) decision making under
uncertainty, (2) finance, (3) econometrics, and (4) capital markets research in accounting. Basic
knowledge of these areas means you are familiar with the material covered in (1) Chapter 2 in Beaver
(1998), and Chapters 1 and 5 in Hirshleifer and Reily (1995); (2) Fama’s Foundation in Finance textbook
or any other PhD level textbook; (3) Greene (2008) and chapters 1, 2, 4, 5, and 7 in Campbell et al.
(1997); (4) Beaver (1998).

I. Evaluation

Grades will be based on the following components:

1. Paper critiques and presentations: 30%

2. Data analysis project: 30%
3. Research proposal: 40%.

Paper critiques and presentations

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Sessions one through twelve include paper presentations by students (or the instructor) and paper
discussions. Everyone should be prepared to discuss the following issues:

The motivation: Why is this research being done? What is the missing link in the (then) current
state of the literature that this paper is trying to address?
The research objectives/questions: What is (are) the specific research question(s)?
The theory: What is the underlying theoretical framework? What assumptions are made in
constructing the arguments?
The specific hypotheses: Do you agree that the hypotheses follow from the logical development of
the arguments? Are these powerful tests of the hypotheses?
The basic model(s): How well does the model represent reality? What sacrifices are being made?
What key insights does the model provide? How does the model differ from or improve upon
models used in other studies?
The research method/design: What are the features of the research design? How do these features
affect external and internal validity? Are there sufficient controls for competing explanations?
Are there any inherent biases or features that may lead to misinterpretations, e.g., lead to type I
and type II errors?
Key research design choices: Which choices are important? What were the alternatives? Did the
author(s) make the best (or at least reasonable) choice?
Interpretations, conclusions and cautionary notes: What do we know after reading the study that
we didn't know before? Are the author's conclusions consistent with the evidence presented? How
do you interpret the evidence?
Limitations of the evidence: What can we not infer? What did we not learn?
Learning by example: What was great about this paper? What was not so great about the paper?
What can we learn from it to help us in our own work?
Future research issues suggested by this research: What questions remain unanswered? What
new questions are raised? How can you address them?

A presentation should strive to communicate the papers’ research questions, motivations, key results,
contributions, research designs, etc. A presenter is expected to explain all concepts, tools, and methods
potentially important for understanding the paper’s message. For example, if a paper uses a GARCH
model, the presenter should be able to explain what a GARCH model is, and why the paper uses it. All
students are expected to have read the assigned papers and participate in the discussion by asking
questions and making comments. I will make paper assignments in our first session.

Research proposal

All students will develop an original research idea related to the course content. Approved topics are
information intermediaries’ activities, the relation between information produced by parties outside the
firm and prices, information processing and belief formation by outsiders, the efficient market hypothesis.
If you are not sure about whether your idea is on an approved topic, ask.

Research proposals will be presented in sessions 13, 14, and 15. Students are required to turn in a 10-12
page document (excluding tables) that would (1) communicate clearly the research question and the
intended contribution to the literature, and (2) convince the reader that the question is answerable, that is,

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key research design issues have been anticipated and solved, data are available or can be gathered at a
reasonable cost, etc. The document will be distributed at least 48 hours prior to the presentation so that the
audience can prepare for the presentation.

By session ten students are expected to turn in a 2-3 page outline and make a 10-15 minutes presentation.
See Class Schedule for when these short presentation will take place, and contact me to schedule yours.

Data Analysis Project

I will make the data available to you. While you are free to discuss your work with others, do not work
together in front of the same computer or exchange code or write-ups. The project has two parts.

Part 1: The properties of analyst consensus forecast errors over time: Bias, accuracy, and
predictability

The objective is to examine how basic forecast error properties change over time.

Define bias as mean or median forecast error, accuracy as mean squared or mean absolute error, and
predictability as the slope coefficient in the regression

estimated using the OLS or the LAD method. Define consensus as the mean of all forecasts issued in the
last 30 days or the most recent forecast.

Conduct year-by-year analyses. Discuss any interesting trends in the properties of consensus forecast
errors, and how the findings depend on the definition of the consensus; propose explanations for these
trends; discuss statistical issues.

Part 2: The quality of common proxies of the market’s earnings expectations

The objective is to evaluate the quality of common proxies of the market’s earnings expectation: past
earnings, and the analyst consensus defined as the most recent forecast or the mean of all forecasts
issued in the last 30 days.

Earnings announcement returns are a function of the unobservable market’s surprise, which is a function
of the unobservable market’s earnings expectation. Assume that returns are a linear function of the
surprise as in

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where is risk-adjusted three-day earnings announcement return, is actual earnings less
the market’s expectation, less . For each proxy estimate the model using OLS and LAD methods.

Interpret the findings and discuss key research design and statistical issues. Question worth addressing:
On the basis of your evidence, which proxy would you use in your own research? Does the choice of a
proxy depend on the research setting? What are the empirical implications of documenting that proxy A is
more accurate than proxy B (lower MSE), but proxy B results in a forecast error more highly correlated
with announcement returns than proxy A?

Turn in a 5-6 page document that clearly states and interprets your findings by Session 12. I will ask some
students to report their findings in a short presentation.

II. Class Schedule

Session 1: The Rational Expectations Hypothesis

Skim:

Section 6.3 in Hirshleifer and Reily (1995)

Muth, J., 1961, Rational Expectations and the Theory of Price Movements, Econometrica 29 (4), 315-
335.

Prepare:

Keane, M. P., and D. E. Runkle, 1998, Are Financial Analysts’ Forecasts of Corporate Profits Rational?
Journal of Political Economy 106 (4), 768-805.

Basu, S., and S. Markov, 2004, Loss Function Assumptions in Rational Expectations Tests on Financial
Analysts’ Earnings Forecasts, Journal of Accounting and Economics 38 (1-3), 171-203.

All students are to turn in before class three fundamental questions (issues) that the papers raise or that
they want to ask the authors. The class discussion will attempt to address select questions. No student
presentations.

Session 2: The Efficient Markets Hypothesis

Chapter 6 in Beaver (1998)

Fama, E. F., 1991, Efficient Capital Markets: II. The Journal of Finance 46 (5): 1575-1617

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All students are to turn in before class three fundamental questions (issues) that the readings raise or that
they want to ask the authors. The class discussion will attempt to address select questions. No student
presentations.

Session 2: Deviations from the rationality ideal: Herding

Chen, Qi, and Wei Jiang. 2006. Analysts' weighting of private and public information. Review of
Financial Studies 19, (1): 319-55.

Jegadeesh N., and W. Kim, 2010, Do analysts herd? An analysis of recommendations and market
reactions? Review of Financial Studies 23 (2): 901-937.

For those interested in Behavioral Economics and Finance, here are some good surveys:

Barberis N., and Thaler, R., 2003, A survey of behavioral finance, In Handbook of the Economics of
Finance, Edited by G.M. Constantinides, M. Harris, and R. Stulz, Elsevier Science.

Shiller, R., 2003, From Efficient Markets Theory to Behavioral Finance, Journal of Economic
Perspectives 17 (1), 83-104

Session 3. Learning and types of learning

Markov, Stanimir, and Ane Tamayo. 2006. Predictability in financial analyst forecast errors: Learning or
irrationality? Journal of Accounting Research 44, (4).

Mikhail, Michael B., Beverly R. Walther, and Richard H. Willis. 2003. The effect of experience on
security analyst underreaction. Journal of Accounting and Economics 35, (1) (4): 101-16.

Session 4: Analyst consensus and the market consensus

Skim:

Patell, J., 1979, The API and the design of experiments, Journal of Accounting Research 17 (2), 528-549.

Prepare:

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Brown, Lawrence D., Robert L. Hagerman, Paul A. Griffin, and Mark E. Zmijewski. 1987. An evaluation
of alternative proxies for the market's assessment of unexpected earnings. Journal of Accounting and
Economics 9, (2) (7): 159-93.

Lys, Thomas, and Sungkyu Sohn. 1990. The association between revisions of financial analysts' earnings
forecasts and security-price changes. Journal of Accounting and Economics 13: 341-63.

Session 5: The relation between analyst research and stock prices

Womack, 1996, Do brokerage house analysts’ recommendations have investment value, Journal of
Finance 51 (1): 137-167.

Altinkilic O., and R. Hansen (2009), On the information role of stock recommendation revisions, Journal
of Accounting and Economics 48: 17-36.

Session 6: Analyst following

The presentations of these papers will be shorter to accommodate presentations of students’ research
proposals.

O'Brien, Patricia C., and Ravi Bhushan. 1990. Analyst following and institutional ownership. Journal of
Accounting Research 28: 55-76.

Bhushan, Ravi. 1989. Collection of information about publicly traded firms : Theory and evidence.
Journal of Accounting and Economics, 11, (2-3) (7): 183-206.

Short presentations of research proposals.

Session 7: Types of information provided by equity analysts

The presentations of these papers will be shorter to accommodate presentations of students’ research
proposals.

DeFond, Mark L., and Mingyi Hung. 2003. An empirical analysis of analysts’ cash flow forecasts.
Journal of Accounting and Economics 35, (1) (4): 73-100.

Lui, Daphne, Stanimir Markov, and Ane Tamayo. 2007. What makes a stock risky? Evidence from sell-
side analysts' risk ratings. Journal of Accounting Research 45, (3): 629-65.

Short presentations of research proposals.

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Session 8: Equity analyst incentives

The presentations of these papers will be shorter to accommodate presentations of students’ research
proposals.

Cowen, Amanda, Boris Groysberg, and Paul Healy. 2006. Which types of analyst firms are more
optimistic? Journal of Accounting and Economics, 41, (1-2) (4): 119-46.

Lim, Terence. 2001. Rationality and analysts' forecast bias. The Journal of Finance 56, (1) (Feb.): 369-
85.

Short presentations of research proposals.

Session 9: Debt market intermediaries: credit rating agencies

Skim:

Partnoy, F., 1999, The Siskel and Ebert of financial markets: Two thumbs down for the credit
rating agencies, Washington University law quarterly (77).

Prepare:

Beaver, William H., Catherine Shakespeare, and Mark T. Soliman. 2006. Differential properties in the
ratings of certified versus non-certified bond-rating agencies. Journal of Accounting and Economics 42,
(3) (12): 303-34.

Blume, Marshall E., Felix Lim, and A. Craig Mackinlay. 1998. The declining credit quality of U.S.
corporate debt: Myth or reality? The Journal of Finance 53, (4, Papers and Proceedings of the Fifty-
Eighth Annual Meeting of the American Finance Association, Chicago, Illinois, January 3-5, 1998)
(Aug.): 1389-413.

Session 10: Debt market intermediaries: Sell-side debt analysts

The presentations of these papers will be shorter to accommodate presentations of students’ research
proposals.

Johnston, R., Markov, S., and Ramnath S., 2009. Sell-side debt analysts. Journal of Accounting and
Economics 47: 91-107.

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DeFranco, G., Vasvari, F., and Wittenberg-Moermnan R. 2009. The Informational Role of Bond
Analysts. Journal of Accounting Research 47(5): 1201-1248.

A good source of information about debt analysts is:

Guiding principles to promote the integrity of fixed-income research, 2004, Securities Industry and
Financial Markets Association, Available at
http://www.sifma.net/assets/files/Guiding_Principles_for_Research.pdf

Short presentations of research proposals.

Session 11: Media

Huberman, Gur, and Tomer Regev. 2001. Contagious speculation and a cure for cancer: A nonevent that
made stock prices soar. The Journal of Finance 56, (1) (Feb.): 387-96.

Bushee, Brian J., John E. Core, Wayne R. Guay, and Sophia Jihae W. Hamm. 2010. The role of the
business press as an information intermediary. Journal of Accounting Research 48 (1): 1-19.

Session 12: Regulation and information intermediaries: Regulation FD

Francis, Jennifer, Dhananjay Nanda, and Xin Wang. 2006. Re-examining the effects of regulation fair
disclosure using foreign listed firms to control for concurrent shocks. Journal of Accounting and
Economics 41, (3) (9): 271-92.

Gintschel, Andreas, and Stanimir Markov. 2004. The effectiveness of regulation FD. Journal of
Accounting and Economics 37, (3) (9): 293-314.

A good sources of information about regulation of analyst research is:

Joint report by NASD and the NYSE on the operation and effectiveness of the research analyst conflict of
interest rules, 2005, Available at
http://www.finra.org/web/groups/industry/@ip/@issues/@rar/documents/industry/p015803.pdf

Session 13: Presentations of Data Analysis Project and Research Proposals

Session 14: Presentations of Research Proposals

Session 15: Presentations of Research Proposals

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 III. Textbooks and useful readings

Textbooks

John Y. Campbell, Andrew W. Lo & A. Craig MacKinlay, 1997, The Econometrics of Financial Markets,
Princeton Univ. Press.

Beaver, W. H., 1998, Financial Reporting: An Accounting Revolution, 3rd edition, Prentice Hall,
Englewood Cliffs.

Hirshleifer, J., and J. Riley, 1995, The Analytics of Uncertainty and Information, Cambridge University
Press.

Greene, W., 2008, Econometric Analysis, 8th Edition, Prentice Hall.

Tips on how to write and present

Cochrane J., 2005, Writing Tips to PhD students, Available on

http://faculty.chicagogsb.edu/john.cochrane/research/Papers/phd_paper_writing.pdf.

McCloskey, D., 2000, Economical Writing, 2nd Edition, Waveland Press.

Piazzesi, M., Tips on how to avoid disaster in presentations, Available on

http://faculty.haas.berkeley.edu/lettau/student_tips/Piazzesi_Presentations.pdf

Books on equity analysts

Groysberg, B., 2010, Chasing Stars: The Myth of talent and portability of performance, Princeton
University Press.

McCellan, S., 2008, Full of bull: Do what Wall Street does, not what it says, to make money in the
market, FT Press.

Reingold, D., 2006, Confessions of an Wall Street analyst, HarperCollins Publishers.

IV. Other information

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