The paper entitled “Unexpected Equity Expansion and Analysts’ EPS Forecasts”, which was jointly written by our school’s Professor Wu Weili, Associate Professor Liu Jie of the College of Economics of Fujian Agriculture and Forestry University, and Professor Zhang Zheng of the Guanghua School of Management of Peking University, has been published in the Journal of Financial Research (Issue 10, 2020).
The paper points to the fact that the current empirical study literature fails to account for the issue of unexpected equity expansion when using the data of analysts’ forecasts on earnings per share (EPS), and discusses the possible consequences and solutions.
Firstly, data of analysts’ EPS forecasts are widely used in empirical studies as a proxy for analysts’ predictions of target companies’ future fundamentals. However, EPS forecasts depend not only on analysts’ predictions of companies’ future net profits, but also on predictions of companies’ future total number of shares. If a target company’s equity expansion after the release of analysts’ earnings forecasts exceeds analysts’ expectations, EPS forecasts no longer represent analysts’ predictions of the company’s future fundamentals. However, the extant domestic empirical literature does not adequately cover this problem.
This paper proposes an adjustment method that can truly reflect analysts’ predictions of a company’s future fundamentals.
Using our adjusted EPS forecasts, we show in two specific empirical research scenarios that when using EPS forecast data, if the impact of unexpected equity expansion is not excluded, erroneous empirical results may be obtained. First, when evaluating the optimistic bias and forecast error in analysts’ EPS forecasts, if we neglect the effects of unexpected equity expansion, the optimistic bias and forecast error of EPS forecasts are systematically overestimated. We find that the relative optimistic bias and relative forecast error of the original EPS forecasts are significantly higher than those of the adjusted EPS forecasts. Second, when investigating the factors affecting the optimistic bias and forecast error of EPS forecasts, if we ignore unexpected equity expansion, we may obtain biased empirical results.
Lastly, the paper further identifies three research scenarios in which ignoring the impact of unexpected equity expansion may lead to erroneous empirical results.
The most common databases currently used by Chinese scholars (e.g. CSMAR) record only the raw EPS forecast data from analysts’ research reports and do not adjust for company equity changes, suggesting that domestic databases are not yet aware of the importance of this issue. The adjustment method proposed in the paper is more scientific and reasonable than that of authoritative foreign databases (I/B/E/S), and is thus of referential significance to Chinese databases.
