Equity Analysts Not So Good at Forecasting Earnings of Spun-off Subsidiaries
A new working paper from Harvard finds that equity analysts don’t do a very good job of making accurate forecasts for subsidiaries of companies that are spun off.
Excerpts from When Do Analysts Add Value? Evidence from Corporate Spinoffs by Emilie Feldman, Stuart Gilson and Belén Villalonga of Harvard Business School.
We investigate equity analysts’ coverage of pending corporate spinoffs, and analyze whether equity analysts provide investors with useful information about the valuation consequences of these transactions. Spinoffs provide an interesting context in which to study the information content of analysts’ research, because the degree of information asymmetry between corporate insiders and investors is especially high in these situations.
Analysts who have followed these firms for an extended time prior to the completion of these spinoffs should have a comparative advantage in forecasting the future stand-alone performance of the parent and subsidiary companies, and in assessing how the spinoffs might impact firms’ market values. At the same time, however, these restructurings are complex, and they may coincide with significant changes in firms’ strategies or markets, potentially limiting analysts’ ability to generate useful information for investors.
We use manually collected data from 1,793 analyst reports that were issued around 62 spinoffs and tracking stock issues to provide detailed empirical evidence about the quantity, type, and quality of research performed by analysts. We find that analysts pay relatively little attention in their reports to the subsidiaries that will be spun off (measured, for example, by page counts, or by whether the reports include explicit forecasts of post-spinoff EPS), even though subsidiaries generally account for an economically significant share of firms’ operations before the spinoff––a result we label as “the forgotten child effect.
Consistent with this lack of attention to subsidiaries, we find that when analysts do provide forecasts of subsidiary EPS, the forecasts are less accurate than corresponding parent EPS forecasts.
Analysts’ forecasts of post-spinoff stock prices for both parents and subsidiaries tend to be less accurate than their EPS forecasts. We show that forecasts of parent EPS are more accurate when analysts or their investment banks have more experience covering the firm or its industry, and when analysts pay relatively more attention to and provide more detailed information about the parent in their reports. Similar cross-sectional variation is not observed in the case of subsidiary EPS forecast errors, however.
Moreover, we establish that when analysts make less accurate forecasts about subsidiaries, they in turn make less accurate forecasts about their parents, providing evidence that by forgetting about the child in their reports, analysts also neglect the parent companies.
Finally, we illustrate that both the EPS and price forecast errors in our sample of spinoffs exceed forecast errors previously documented in the context of other corporate restructuring transactions, such as IPOs, mergers, and bankruptcies. We conclude that the complexity associated with forecasting earnings and stock prices in the context of corporate spinoffs, combined with analysts’ apparent disregard for subsidiaries in their analysis of corporate spinoffs, seem to limit analysts’ ability to add value as information intermediaries in this setting.
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