The Role of Debt Contracts in Analyst Earnings Forecasts

• In Event: Financial II

Abstract

Financial analysts evaluate a firm’s performance and provide earnings forecasts for future quarters and years. Analysts have limited access to firm financial information, particularly following the enactment of Regulation Fair Disclosure (Reg FD) on October 23, 2000 which results in information asymmetry between analysts and firm insiders. However, banks are exempt from the Reg FD, and they can still access private information in order to qualify their borrowers for better loans. Analysts can accordingly use loan contracts as a source of information to reduce information asymmetry to improve their earnings forecasts. We find that during the quarters that companies sign loan contracts, analysts provide more accurate earnings forecasts with lower forecast errors. More importantly, we find that analysts revise their earnings forecasts upward following the issuance of loans with low interest rates, while they revise them down following the issuance of loans with high interest rates. Overall, the results indicate that financial analysts use the information provided in debt contracts to better evaluate a firm’s performance and provide more precise earnings forecasts.

Authors

• Bishal BC, Grand Valley State University - Grand Rapids

• Sharif Esfahani, University of Texas at Dallas