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

This study examines the response of First Call financial analysts to com-pany restatements and corrective disclosures that lead to an allegation of securities fraud and compares this with the response of three other in-formed investor groups-insiders, short sellers, and institutions. The sam-ple comprises 847 companies that have been sued in a federal securities class action from 1994 through 2001 with requisite stock price and com-pany data. I document that the number of analysts covering a firm declines signijicantly in the months following a corrective disclosure. I also doc-ument 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 signijicantly in the cor-rective disclosure month but not before. On the other hand, informed groups such as insiders, short sellers, and institutional managers are un-usually 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 predisclosure net insider selling and institutional holdings are higher and when the market reacts more negatively to the announcement. 1