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Rev Fin 2002; 15:869-900
© 2002 the Society for Financial Studies

Why New Issues and High-Accrual Firms Underperform: The Role of Analysts' Credulity

Siew Hong Teoh
Siew Hong Teoh, Ohio State University

T. J. Wong
T. J. Wong, Hong Kong University of Science and Technology

Address correspondence to Siew Hong Teoh, Fisher College of Business, 400 Fisher Hall, 2100 Neil Avenue, Ohio State University, Columbus, OH 43210, or e-mail: teoh_2{at}cob.osu.edu

Abstract

We find that analysts' forecast errors are predicted by past accounting accruals (adjustments to cash flows to obtain reported earnings) among both equity issuers and nonissuers. Analysts are more optimistic for the subsequent four years for issuers reporting higher issue-year accruals. The predictive power is greater for discretionary accruals than nondiscretionary accruals and is independent of the presence of an underwriting affiliation. Predicted forecast errors from accruals significantly explain the long-term underperformance of new issuers. The predictability of forecast errors among nonissuers suggests that analysts' credulity about accruals management more generally contributes to market inefficiency.


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