1. 1 Analysts’ Incentives and the Dispersion Effect Chuan-Yang Hwang Yuan Li

2. 2 Puzzle (Diether, Malloy and Scherbina (2002) ) A negative cross-sectional relationship between dispersion in analysts’ earnings forecasts and future stock return (the dispersion effect).

3. 3 Explanations in the Literature DMS: (Miller 1977) difference of opinion Johnson (2004): information risk Sadka and Scherbina (2007):analyst disagreement and information asymmetry Commonalities: Dispersion is viewed as an exogenous variable Measure as information uncertainty, cause of lower stock return

4. 4 Our explanation: Analysts’ incentive of not fully downward revising their forecasts when they possess bad news would simultaneously increase forecast dispersion and induce an upward bias in consensus forecasts, and stock price.

5. 5 Analysts’ Incentive to issue optimistic opinions Investment banking business (Dugar et al. (1995), Lin and McNichols (1998,2005), Dechow et al. (2000), Michaely and Womack (1999) ) Trading Volume ( Cowen et al. (2006), P.J.Irvine (2001)) Access to managers’ information (Francis and Philbrick (1993), Das, Levine, Sivararnarkrishnan (1998), Lim (2001)) Career Concern ( Hong and Kubik (2003) )

6. Incentives are more pervasive among firms have bad yet publicly unknown information: Non-incentive driven analysts—downward revise forecasts promptly Incentive driven analysts-reluctant to downward revise --dispersion increase and an upward bias in consensus forecast 6

7. 7 3.0 2.5 2.0 2.5 2.0 1.5 Bad News -0.5 3.0 Dispersion Increase Upward Bias:0.5/3

8. 8 Supporting Result (1) The dispersion effect exists only among bad news firms.

9. Supporting Result (2) Analysts’ incentive, change in dispersion, and upward bias in consensus forecasts increase with level of dispersion among bad news firms. 9

10. 10 Supporting Result (3) After controlling for incentive-induced upward bias embedded in consensus earnings forecasts, the dispersion effect disappears.

11. 11 Supporting Result (4) Firms with low information uncertainty exhibits stronger dispersion effects as high forecast dispersion is more likely to be generated by analysts’ incentive.

12. 12