Alternative Evidence on Financial Analysts' Use of Financial Statement Information

Financial analysts are frequently viewed as information intermediaries who process and interpret firms' financial reports for other market participants. However, much research results cast doubts on analysts' ability to fully utilize the information in firms' financial reports (e.g., see Bradshaw et al. 2001). This study provides evidence on how sophisticated analysts are at using information in firms' financial reports. We estimate different measures of firms' operational efficiency, all of which are derived from financial statement data, and compare the strength of the association between these measures and analysts' absolute forecast errors. We compare a sophisticated frontier-based measure of firms' operational efficiency that evaluates firms' performance relative to their competitors with three more traditional efficiency measures; specifically (1) the return on asset (ROA) ratio, (2) industry-adjusted ROA (AROA), and (3) the return on equity (ROE) ratio. Our results indicate that the more sophisticated frontier-based measure is more strongly negatively associated with analysts' absolute forecast errors than the other three measures. The results suggest that analysts are capable of undertaking a sophisticated analysis of the information in firms' financial reports, at least as it pertains to operational efficiency