A League of Their Own? Financial Analysts' Responses to Restatements and Corrective Disclosures

This study examines the response of First Call financial analysts to company restatements and corrective disclosures that lead to an allegation of securities fraud and compares this with the response of three other informed investor groups - insiders, short sellers, and institutions. The sample comprises 847 companies that have been sued in a federal securities class action from 1994 through 2001 with requisite stock price and company data. I document that the number of analysts covering a firm declines significantly in the months following a corrective disclosure. I also document that analysts are more likely to revise their forecasts down in the month of or up to six months following a corrective disclosure but not before. Similarly, analyst forecast error decreases significantly in the corrective disclosure month but not before. On the other hand, informed groups such as insiders, short sellers, and institutional managers are unusually active several months ahead of a corrective disclosure event. These individuals, apparently, take positions in anticipation of the news that may lead to such an event. Finally, a regression analysis indicates that after controlling for size, coverage, and other variables, analyst forecast error just prior to a corrective disclosure is reliably greater when pre-disclosure net insider selling and institutional holdings are higher and when the market reacts more negatively to the announcement