An Empirical Investigation of Analysts’ Objective Function

Assumptions about sell-side analysts’ objective function are critical to empirical researchers’ understanding of their incentives and the resulting behavior. This paper provides empirical evidence about the objective function underlying analysts’ choice of forecasts. In contrast to approaches used in previous papers which rely exclusively on statistical properties of forecasts, I compare theoretical models with alternate objective functions based on their ability to explain observed forecasts. A linear loss objective function which incorporates the effect future analysts’ actions on analysts’ deviation from peer forecasts is best rationalized by the data. I find that assumptions about the objective function has a substantial impact on the conclusions from empirical tests about analysts’ incentives and resulting behavior. Doctoral Candidate in Accounting, Graduate School of Business, Stanford University. E-mail: [email protected]. I am deeply indebted to Dave Larcker and Peter Reiss for their invaluable advice. I also thank Mary Barth, Anne Beyer, Ed deHaan, Ron Dye, Mike Klausner and Stefan Reichelstein for helpful comments and discussions. Financial support from the Chartered Accountants Education Foundation and the Social Sciences and Humanities Council of Canada is gratefully acknowledged. All errors are my own.