Are Analysts' Cash Flow Forecast Useful ?

Accounting and Finance 55 (2015) 825–859
Are analysts’ cash flow forecasts useful?
Sung Hwan Jung

College of Economics and Business Administration, University of Suwon, Hwaseong, Korea
Abstract
This study provides evidence that the cost of equity capital decreases with the
number of analysts who issue both cash flow and earnings forecasts (cash
analysts). The evidence also shows that cash analysts reduce information
asymmetry and predict long-term earnings more accurately than analysts who
issue only earnings forecasts. Taken together, these findings suggest that cash
analysts provide market participants with high-quality information and, as a
result, firms benefit from cash analyst coverage in the form of a reduced cost of
equity capital.
Key words: Analysts’ cash flow forecasts; Cost of equity capital; Long-term
forecast accuracy
JEL classification: G24, G30
doi: 10.1111/acfi.12103
1. Introduction
Analysts’ cash flow forecasts are becoming more common. Previous studies
examine the determinants of investors’ demand for cash flow forecasts
(DeFond and Hung, 2003), the information content of analysts’ cash flow
forecasts (Givoly et al., 2009; Call et al., 2013), the determinants of the
accuracy of cash flow forecasts (Yoo and Pae, 2011; Pae and Yoon, 2012), their
effects on relative earnings forecast accuracy (Call et al., 2009) and their effects
on managerial behaviour (McInnis and Collins, 2011). Whereas prior research
This paper is based on my dissertation at Korea University. I am grateful to Steven

Cahan and an anonymous reviewer for insightful comments and suggestions. I thank the
members of my dissertation committee: Bok Baik, Sam Han (Chair), Wooseok Choi,
Jinhan Pae, and Seung-Weon Yoo. I also acknowledge comments from Sudipta Basu
and workshop participants at the 2013 AAA meeting.
Received 27 March 2014; accepted 24 November 2014 by Steven Cahan (Editor in Chief).
© 2015 AFAANZ
826 S. H. Jung/Accounting and Finance 55 (2015) 825–859
has examined the demand for and consequences of analysts’ cash flow
forecasts, how these forecasts affect the cost of equity capital is unclear. The
association may be affected by the quality of the cash flow forecasts and
information environment.
Easley and O’Hara (2004) explore the link between information and the cost
of capital and demonstrate that the cost of capital increases in the fraction of
private information in the information set about firm value and decreases in the
quality of public information.1 The effect of analysts’ cash flow forecasts on the
cost of equity capital, thus, depends on how cash analyst coverage affects these
information-related attributes.2 If analysts’ cash flow forecasts have substantial
information content suggesting that greater cash analyst coverage leads to
increases in the fraction of public information or increases in the quality of
public information, theory would predict a decrease in the cost of equity capital
with an increase in cash analyst coverage. However, analysts’ cash flow
forecasts may not contain enough high-quality information to successfully
address investors’ information needs or may not have incremental information
content over other information. These competing views justify further
examination of the effect of cash analyst coverage on the cost of equity capital.
Using a large sample of firms from Institutional Brokers’ Estimate System (I/
B/E/S) for the period 1993–2009, this study provides several important
findings. First, the results show that after controlling for other determinants of
cash analyst coverage, cash analyst coverage is higher for firms with high cost
of equity capital. Considering that firms with high information risk generally
have a higher cost of equity capital, this finding is consistent with DeFond and
Hung’s (2003) demand hypothesis that analysts issue cash flow forecasts for
firms whose earnings do not play a sufficient role as public information, that is,
for firms with high information risk. In addition, this evidence suggests that for
firms which attract cash analysts, the cost of equity capital likely reflects greater
information risk, and thus, information intermediaries can play a significant
role in reducing firms’ cost of equity.3 Consistent with this expectation, this
study shows that after controlling for firm risk factors and the determinants of
cash analyst coverage, cash analyst coverage is negatively associated with the
cost of equity capital. This finding suggests that analysts’ cash flow forecasts
have substantial information content and that they can increase the quality or
fraction of public information. These results are economically and statistically
significant and are robust to various model specifications (including change and
1
Bhattacharya et al. (2011) find evidence of both a direct path from information risk to
the cost of equity capital and an indirect path that is mediated by information
asymmetry.
2
This study interchangeably uses cash analysts with analysts who provide both cash
flow and earnings forecasts.
3
In contrast, I find a negative association between analyst following and the cost of
equity capital before and after controlling for the size effect (untabulated).
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S. H. Jung/Accounting and Finance 55 (2015) 825–859 827
difference-in-differences specifications), subsamples, and different measures of

cost of equity capital and cash analyst coverage.
The evidence also shows that cash analysts issue more accurate long-term
earnings forecasts than analysts who issue only earnings forecasts. This finding
provides an explanation for the significant role of cash analyst coverage in
reducing the cost of equity capital. As the cost of equity capital is affected by
both near- and long-term uncertainty, the beneficial effect of analysts’ cash flow
forecasts on the cost of equity capital exists only when cash analyst coverage
mitigates not only near- but also long-term uncertainty. This finding of this
study, along with the evidence that cash analysts have more accurate short-
term earnings forecasts (Call et al., 2009), supports the view that cash analysts
possess a superior ability to reduce not only near- but also long-term
uncertainty. Finally, I find that cash analyst coverage is negatively associated
with the probability of informed trading (PIN) from Brown et al. (2004). This
suggests that one of the ways that cash flow forecasts reduce cost of equity
capital is through a reduction of information asymmetry.
This study contributes to the extant literature in several ways. First, this
study adds to the literature on analyst cash flow forecasts (e.g. DeFond and
Hung, 2003; Givoly et al., 2009; McInnis and Collins, 2011; Yoo and Pae,
2011; Pae and Yoon, 2012; Call et al., 2013), where there is a continuing
debate on the quality of analysts’ cash forecasts. Second, this study extends
the literature on the association between analyst coverage and the cost of
capital (e.g. Easley and O’Hara, 2004; Bowen et al., 2008; Kelly and
Ljungqvist, 2012; Derrien and Kecskes, 2013). Evidence from prior studies
suggests that analysts’ activities contribute to increases in the fraction of or in
the quality of public information, thereby reducing the cost of capital.
However, the understanding is incomplete regarding which type of analyst
activities contribute to a reduction in the cost of equity capital. This study
adds to the literature by focusing on a specific activity of analysts, that is, cash
flow forecast activity. Third, this study is related to the literature on
disaggregated earnings forecasts and forecast accuracy. Prior studies find that
analysts who issue both earnings forecasts and forecasts of earnings
components, such as cash flow or revenue, have superior forecasting ability
(Call et al., 2009; Keung, 2010; Ertimur et al., 2011). They focus on analysts’
forecasting ability with respect to 1-year-ahead earnings. I complement and
extend the literature by showing that analysts who disaggregate their earnings
forecasts into cash and accrual components provide more accurate long-term
(2-year-ahead) earnings forecasts, which are useful in mitigating long-term
uncertainty.
This paper proceeds as follows: Section 2 discusses the related literature and
develops the hypothesis; Section 3 describes my research design and data;
Section 4 presents empirical evidence; Section 5 provides additional analyses;
and Section 6 concludes the paper.
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2. Related research and hypothesis development
2.1. Information intermediary and cost of equity capital
Two potential links between analyst coverage and the cost of equity capital
can be established based on theoretical research. First, Merton’s (1987) model
of capital markets with incomplete information shows that investors only hold
securities they know about. Analysts can increase investors’ awareness of a
firm, leading to an increase in the size of the investor base and thus increased
demand for the firm’s securities (Bowen et al., 2008). This increased demand
for the firm’s securities in turn raises the current price, that is, reduces the cost
of equity capital.
The second potential link is related to the theoretical research that explores
the link between information and the cost of capital. Easley and O’Hara
(2004) develop the multiple-asset and multiple-signal rational expectations
equilibrium model and show that the distribution of information affects the
cost of capital. This implies that uninformed investors’ portfolios always
include too many stocks with bad news, and too few stocks with good news,
relative to portfolios of informed investors; thus, the uninformed require
compensation for bearing information risk.4 This finding suggests that analyst
coverage affects investors’ required return. Analysts are among the most
influential information producers in financial markets. They collect and
disseminate information to market participants, that is, gather information
from various sources both internal and external to a firm and provide an
assessment to external parties (e.g. Hong et al., 2000; Ayers and Freeman,
2003; Bowen et al., 2008). During this process, analysts likely increase the
quality or precision of public information, which leads to increased fraction
of public information, decreased information asymmetry and decreased cost
of equity capital.
In addition, given that investors demand risk premiums to compensate for
loss from managerial expropriation (e.g. Bushman and Smith, 2001), another
potential link between analysts’ activities and the cost of equity capital may
be established based on the role of analysts as external monitors of
managers (Jensen and Meckling, 1976; Moyer et al., 1989; Yu, 2008; Dyck
et al., 2010).
The results of previous research confirm this conjecture. Bowen et al. (2008)
provide evidence that analyst coverage reduces the underpricing of seasoned
equity offerings (SEO). They also show that analysts working for the lead
underwriter, Institutional Investor All-American analysts, or analysts following
firms with low earnings forecast dispersion, reduce SEO underpricing further
than other analysts. This evidence supports the notion that analysts play a key
4
This information risk is systematic in the sense that holding more stocks does not
eliminate this risk (Easley and O’Hara, 2004).
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role in the acquisition and dissemination of information in capital markets, and

explains why firms, prior to SEOs, place such high value on analyst research
coverage (Krigman et al., 2001; Bowen et al., 2008).
Relatedly, Kelly and Ljungqvist (2012) find that changes in analyst coverage
affect asset pricing. They interpret this finding as suggesting that a reduction in
analyst coverage limits uninformed investors’ access to a previously available
signal and thereby increases the degree of information asymmetry between
uninformed and informed investors. In turn, this increases the risk premium,
which decreases the asset’s price. In the same vein, Derrien and Kecskes (2013)
document that a decrease in analyst coverage – through an increase in
information asymmetry and cost of capital – causes a decrease in investment
and financing.
2.2. Analysts’ cash flow forecasts and cost of equity capital
DeFond and Hung (2003) are the first study to investigate analysts’
increasing propensity to issue cash flow forecasts. They find that analysts tend
to issue cash flow forecasts for firms whose earnings are not sufficiently
informative, for example, firms with large accruals, heterogeneous accounting
choices relative to industry peers, high earnings volatility, high capital
intensity and financial distress. In addition, DeFond and Hung (2003)
document that stock returns around annual earnings announcement dates for
firms with cash flow forecasts are positively associated with cash flow forecast
errors but not with earnings forecast errors, suggesting that analyst cash flow
forecasts convey information and complement the information contained in
earnings.5
Call et al. (2009) show that the relative forecast accuracy of short-term
earnings is higher in the presence of cash flow forecasts. This implies that
analysts who issue cash flow forecasts provide more useful public
information (i.e. earnings forecasts) than other analysts. Part of the
reason for this is that analysts adopt a more structured and disciplined
approach to forecasting earnings when they also issue cash flow forecasts
in addition to earnings forecasts (Call et al., 2009). This evidence suggests
5
The effect of analyst coverage on the cost of equity capital is likely to be significant
only when investors have information needs that arise from information asymmetry or a
lack of information. In extreme cases in which no information component of a firm’s
cost of equity capital exists, even analysts with high-quality research outputs cannot
affect the firm’s equity cost of capital. In short, the existence of investors’ information
needs may be said to be a necessary condition for the significant effect of analyst
coverage on the cost of equity capital. In addition, because the cost of equity capital is a
direct function of investors’ perceived risk, it can also be said that analysts’ research
outputs that are driven by investors’ information needs are in a better position to reduce
the cost of equity capital.
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that the quality of public information increases, as cash analyst coverage

increases.
Given the evidence that analyst-provided information affects the cost of
equity capital (e.g. Easley and O’Hara, 2004; Bowen et al., 2008; Kelly
and Ljungqvist, 2012; Derrien and Kecskes, 2013), the above findings
suggest that cash analyst coverage contributes to a reduction in the cost of
equity capital. However, whether or not this reduction occurs is not
obvious because the effect of cash analyst coverage on the cost of equity
capital depends on the extent that analyst cash flow forecasts are of high
quality.
Whether cash flow forecasts have information content is a highly debated
issue. On the one hand, there are several findings which directly or
indirectly indicate that cash flow forecasts have substantial information
content. Call et al. (2013) and Pae and Yoon (2012) argue that analyst
cash flow forecasts reflect meaningful accrual adjustments. Call et al.
(2013) find a significant market reaction to analysts’ cash flow forecast
revisions. McInnis and Collins (2011) provide evidence that cash analysts
deter earnings management, which suggests that they increase the trans-
parency of accrual manipulations and as a result make management-
provided information informative. On the other hand, Givoly et al. (2009)
find that analyst cash flow forecasts are less accurate than analyst earnings
forecasts, improve at a slower rate during the forecast period and are
weakly associated with stock returns. In particular, they argue that
analysts’ cash flow forecasts are simply na€ıve extensions of existing
earnings forecasts, which concludes that analyst cash flow forecasts are of
limited information content. Consistent with Givoly et al. (2009), Brown
and Christensen (2014) find that a significant portion of analysts ignore
working capital and other accruals when adjusting earnings forecasts to
arrive at their cash flow forecasts.
If the argument by Givoly et al. (2009) is true (i.e. analysts fail to
accurately forecast accrual components), does it mean that analysts’ cash
flow forecasts are of low quality? Alternatively, does it mean that analyst
earnings forecasts, which contain low-quality forecasts of accrual compo-
nents, are of low quality and analyst cash flow forecasts, which do not
contain these components, are of high quality? Additionally, the cost of
equity capital is affected by both near- and long-term uncertainty, and thus,
the beneficial effect of cash analyst coverage on the cost of equity capital
exists only when cash analysts mitigate not only near- but also long-term
uncertainty. However, it is unresolved whether cash analysts have the ability
to reduce long-term uncertainty. In sum, it is unclear whether cash analyst
coverage contributes to a reduction in the cost of equity capital. This leads
to the following hypothesis (in null form):
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H1: The cost of equity capital is not associated with the number of analysts who
issue both cash flow and earnings forecasts.
3. Sample selection and methodology
3.1 Data
My initial sample includes the firm-years listed on the Compustat XPF files for
the period 1993–2009. I obtain analyst coverage data from the I/B/E/S Detail
History US Edition database. My sample period begins in 1993 because analyst
cash flow forecasts begin to appear in the I/B/E/S database in 1993. Consistent
with prior research, I exclude (i) financial institutions and insurance companies,
(ii) firm-year observations without analyst coverage, (iii) non-U.S. firms and (iv)
firms with non-December fiscal year-ends as I calculate the implied cost of equity
capital at a fixed date (i.e. at the end of June). Based on my sample criteria, I
obtain 5,001 firm-year observations from 1,338 unique firms.
3.2. Measurement of the implied cost of equity capital
I use the discount rate implied from variations on the residual income
valuation model to estimate the ex-ante cost of equity capital. Specifically, I
evaluate the proxies for the ex-ante cost of equity capital using the
methodologies described in Gebhardt et al. (2001), Claus and Thomas
(2001), Easton (2004), and Gode and Mohanram (2003). I refer to these
estimates as rgls, rct, rmpeg and rgm, respectively.
3.3. Model specification
To test my hypothesis, I estimate the following Equation (1)6 :
CCi;t ¼ b0 þ b1 Cash Ci;t1 þ b2 LTGi;t þ b3 LNDISPi;t þ b4 lnMVi;t þ b5 MBi;t

þ b6 BETAi;t þ b7 M Acci;t þ b8 Acc Hi;t þ b9 Earn Vali;t þ b10 Cap Inti;t
þ b11 Altmani;t þ b12 Neg Ri;t þ b13 Lossi;t þ b14 N SFi;t þ b15 N RFi;t
þ b16 N EFi;t þ Year indicators þ Industry indicators þ ei;t
ð1Þ
6
I assess the significance of my regression coefficients using standard errors adjusted for
firm- and year-level clustering, as my sample consists of repeated observations of the
same firms and the same years, and thus, the residuals may be correlated across firms or
across time (Petersen, 2009).
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where CC is one of my five proxies for the cost of equity capital (rgls, rct,
rmpeg, rgm or COC, which is the average of the four cost of equity capital
proxies). Cash_C is cash analyst coverage. LTG is measured as the
difference between the 2-year-ahead consensus EPS forecast and the 1-
year-ahead consensus EPS forecast scaled by the 1-year-ahead consensus
EPS forecast. LNDISP is calculated as the natural logarithm of the
coefficient of the variation in year t earnings forecasts issued in June. lnMV
is the natural logarithm of the market value of equity. MB is the ratio of
market to book values. BETA is the systematic risk, estimated using 60
monthly return data. M_Acc is the absolute of the difference between net
income before extraordinary items and operating cash flows deflated by
total assets. Acc_H captures the comparability of a firm’s accounting choice
with its industry peers and is computed as follows: each firm is assigned a
value of one whenever its accounting choice is different from the most
frequently chosen accounting method in its industry group, for each of the
following accounting choices: (i) inventory valuation, (ii) investment tax
credit, (iii) depreciation, (iv) successful efforts vs. full cost for companies
with extraction activities and (v) purchase vs. pooling. Acc_H is estimated
as the total assigned scores for each firm scaled by the number of
accounting choices in the industry.7 EarnVal is the coefficient of variation of
earnings measured over the sample period, where earnings is earnings
per share before extraordinary items scaled by beginning stock price.
Cap_Int is the ratio of gross property, plant and equipment to sales revenue.
Altman is 1.2 (Net working capital/Total assets) + 1.4 (Retained earnings/
Total assets) + 3.3 (Earnings before interest and taxes/Total assets) + 0.6
(Market value of equity/Book value of liabilities) + 1.0 (Sales/Total assets)
(Altman, 1968). Neg_R is a dummy variable set equal to 1 for firms with
negative return, and 0 otherwise. Loss is a dummy variable set equal to 1
for firms with negative earnings, and 0 otherwise. N_SF denotes the natural
logarithm of one plus the number of analysts who issue both sales and
earnings forecasts. N_RF denotes the natural logarithm of one plus the
number of analysts who issue both ROA and earnings forecasts. N_EF
denotes the natural logarithm of one plus the number of analysts who issue
earnings forecasts.
My main variable of interest is cash analyst coverage (N_CFF), which is
defined as the natural logarithm of one plus the number of analysts who issue
both cash flow and earnings forecasts.8 To the extent that cash analysts succeed
7
According to DeFond and Hung (2003), if a firm has a missing value for a given
accounting choice, the choice is coded as zero.
8
Specifically, N_CFF is the natural logarithm of one plus the number of unique analysts
who issue both cash flow and earnings forecasts during the 1 year before the date of cost
of equity capital estimation (i.e. the end of June).
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in meeting investors’ information needs, I expect a negative coefficient on cash

analyst coverage (N_CFF).9
Consistent with prior research, I control for firm characteristics that are
correlated with the cost of equity capital measures. I include the long-term
growth rate (LTG), as Gebhardt et al. (2001) and Gode and Mohanram
(2003) find that the implied cost of equity capital is positively associated
with long-term growth rate. Analyst forecast dispersion (LNDISP) is
included following Gebhardt et al. (2001) and Dhaliwal et al. (2006).10 As
prior literature finds that expected returns are negatively associated with firm
size and the market-to-book ratio (Stattman, 1980; Banz, 1981; Fama and
French, 1992), I include firm size (lnMV) and the market-to-book ratio
(MB). The market model beta (BETA) is included to control for systematic
risk. The determinants of market participants’ demand for cash flow
information are also included as follows: magnitude of accruals (M_Acc),
comparability of accounting choices (Acc_H), earnings volatility (EarnVal),
capital intensity (Cap_Int) and financial distress (Altman). Firm performance
(Neg_R and Loss) is included to control for the effect of recent firm
performance on the decision to cover a firm and the cost of equity capital. I
also include other disaggregated forecasts, that is, sales (N_SF) and ROA
(N_RF) forecasts, and analyst coverage (N_EF) to investigate the incremen-
tal effect of cash analysts.
4. Empirical results
Table 1 presents the descriptive statistics for the variables used in the
regression analyses. In Panel A, the descriptive statistics are generally
consistent with those obtained in prior research (e.g. Botosan and Plumlee,
2005; Dhaliwal et al., 2006). For example, rgls has the smallest mean value
among the cost of equity capital estimates with a mean (median) of 0.096
(0.094), whereas rgm has the largest mean value with a mean (median) of 0.119
(0.106) (e.g. Botosan and Plumlee, 2005; Dhaliwal et al., 2006). The number of
cash analysts (N_CFF) before taking logarithm has a mean (median) of 2.706
(1) and its standard deviation is 5.146, suggesting that three analysts, on
average, issue both cash flow and earnings forecasts, and there is a substantial
variation in cash analyst coverage across firms. In Panel B, I report Pearson
correlations. As expected, five cost of equity capital variables (rgls, rct, rmpeg, rgm
and COC) are positively correlated with each other (p < 0.001), and the
9
The results are similar when I use the ratio of the number of cash analysts to that of
analysts as an alternative proxy for cash analyst coverage.
10
Gebhardt et al. (2001) find that analyst forecast dispersion is negatively associated
with the cost of equity capital, and Dhaliwal et al.(2006) find that depending on the cost
of equity capital measures, analyst forecast dispersion is negatively or positively
associated with the cost of equity capital.
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Table 1
Summary statistics. (A) Descriptive statistics. (B) Pearson correlations
Variable N Mean SD 25% 50% 75%
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(A)
COC 5,001 0.111 0.057 0.079 0.098 0.125
rgls 5,001 0.096 0.038 0.072 0.094 0.115
rct 5,001 0.117 0.111 0.066 0.089 0.118
rmpeg 5,001 0.113 0.053 0.079 0.101 0.133
rgm 5,001 0.119 0.053 0.086 0.106 0.139
N_CFF 5,001 0.781 0.923 0.000 0.693 1.386
N_CFF (raw) 5,001 2.706 5.146 0.000 1.000 3.000
LTG 5,001 0.432 0.853 0.121 0.190 0.356
LNDISP 5,001 0.087 0.113 0.020 0.047 0.106
lnMV 5,001 7.818 1.675 6.659 7.767 8.930
MB 5,001 3.507 3.251 1.699 2.505 3.977
BETA 5,001 0.815 0.612 0.387 0.698 1.127
M_Acc 5,001 0.069 0.059 0.031 0.055 0.089
Acc_H 5,001 0.149 0.152 0.000 0.200 0.200
EarnVal 5,001 0.004 0.009 0.000 0.001 0.003
Cap_Int 5,001 1.148 1.298 0.325 0.618 1.400
Altman 5,001 4.705 5.133 1.933 3.147 5.214
Neg_R 5,001 0.436 0.496 0.000 0.000 1.000
Loss 5,001 0.121 0.327 0.000 0.000 0.000
N_SF 5,001 1.582 1.115 0.693 1.792 2.485
S. H. Jung/Accounting and Finance 55 (2015) 825–859
N_SF (raw) 5,001 7.355 8.218 1.000 5.000 11.000

N_RF 5,001 0.308 0.517 0.000 0.000 0.693
N_RF (raw) 5,001 0.613 1.208 0.000 0.000 1.000
(continued)
Table 1 (continued)
Variable N Mean SD 25% 50% 75%
N_EF 5,001 2.718 0.580 2.398 2.773 3.135

N_EF (raw) 5,001 16.701 9.608 10.000 15.000 22.000
COC 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
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(B)
2. rgls 0.699
<0.001
3. rct 0.680 0.479
<0.001 <0.001
4. rmpeg 0.886 0.474 0.412
<0.001 <0.001 <0.001
5. rgm 0.910 0.469 0.515 0.933
<0.001 <0.001 <0.001 <0.001
6. N_CFF 0.041 0.064 0.055 0.005 0.022
0.004 <0.001 <0.001 0.724 0.119
7. LTG 0.597 0.232 0.659 0.474 0.495 0.050
<0.001 <0.001 <0.001 <0.001 <0.001 <0.001
8.LNDISP 0.341 0.315 0.265 0.366 0.348 0.285 0.118
<0.001 <0.001 <0.001 <0.001 <0.001 <0.001 <0.001
9. lnMV 0.322 0.289 0.282 0.290 0.296 0.263 0.212 0.041
<0.001 <0.001 <0.001 <0.001 <0.001 <0.001 <0.001 0.004
10. MB 0.158 0.207 0.095 0.167 0.157 0.087 0.068 0.091 0.273
<0.001 <0.001 <0.001 <0.001 <0.001 <0.001 <0.001 <0.001 <0.001
11. BETA 0.245 0.267 0.195 0.229 0.224 0.108 0.183 0.052 0.341 0.013
<0.001 <0.001 <0.001 <0.001 <0.001 <0.001 <0.001 <0.001 <0.001 0.355
12. M_Acc 0.068 0.049 0.068 0.058 0.056 0.131 0.079 0.071 0.120 0.055 0.142
<0.001 <0.001 <0.001 <0.001 <0.001 <0.001 <0.001 <0.001 <0.001 <0.001 <0.001
(continued)
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Table 1 (continued)
COC 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
13. Acc_H 0.036 0.116 0.038 0.067 0.084 0.182 0.077 0.117 0.080 0.036 0.088 0.057
0.011 <0.001 0.007 <0.001 <0.001 <0.001 <0.001 <0.001 <0.001 0.011 <0.001 <0.001
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14. EarnVal 0.091 0.098 0.066 0.094 0.092 0.001 0.056 0.038 0.102 0.027 0.135 0.052 0.007
<0.001 <0.001 <0.001 <0.001 <0.001 0.931 <0.001 0.007 <0.001 0.054 <0.001 <0.001 0.646
15. Cap_Int 0.006 0.119 0.013 0.010 0.015 0.453 0.080 0.172 0.029 0.181 0.218 0.148 0.187 0.022
0.684 <0.001 0.374 0.493 0.295 <0.001 <0.001 <0.001 0.038 <0.001 <0.001 <0.001 <0.001 0.123
16.Altman 0.098 0.078 0.064 0.124 0.115 0.187 0.000 0.140 0.009 0.339 0.183 0.054 0.141 0.002 0.318
<0.001 <0.001 <0.001 <0.001 <0.001 <0.001 0.991 <0.001 0.540 <0.001 <0.001 <0.001 <0.001 0.889 <0.001
17. Neg_R 0.037 0.060 0.014 0.047 0.040 0.008 0.022 0.001 0.016 0.034 0.011 0.030 0.028 0.001 0.052 0.051
0.010 <0.001 0.318 <0.001 0.005 0.550 0.124 0.958 0.269 0.017 0.421 0.032 0.050 0.951 <0.001 <0.001
18. Loss 0.207 0.159 0.180 0.196 0.197 0.019 0.194 0.053 0.160 0.003 0.236 0.407 0.014 0.092 0.051 0.108 0.092
<0.001 <0.001 <0.001 <0.001 <0.001 0.171 <0.001 <0.001 <0.001 0.857 <0.001 <0.001 0.309 <0.001 <0.001 <0.001 <0.001
19. N_SF 0.087 0.117 0.126 0.064 0.130 0.381 0.039 0.009 0.312 0.146 0.157 0.043 0.140 0.048 0.115 0.145 0.076 0.026
<0.001 <0.001 <0.001 <0.001 <0.001 <0.001 0.005 0.506 <0.001 <0.001 <0.001 0.002 <0.001 <0.001 <0.001 <0.001 <0.001 0.071
20. N_RF 0.059 0.076 0.102 0.021 0.072 0.351 0.064 0.048 0.273 0.019 0.051 0.005 0.095 0.024 0.104 0.023 0.111 0.015 0.618
<0.001 <0.001 <0.001 0.143 <0.001 <0.001 <0.001 <0.001 <0.001 0.191 <0.001 0.717 <0.001 0.084 <0.001 0.106 <0.001 0.290 <0.001
21. N_EF 0.262 0.261 0.222 0.240 0.230 0.354 0.110 0.049 0.696 0.162 0.193 0.003 0.083 0.028 0.140 0.033 0.044 0.079 0.277 0.213
<0.001 <0.001 <0.001 <0.001 <0.001 <0.001 <0.001 <0.001 <0.001 <0.001 <0.001 0.860 <0.001 0.048 <0.001 0.019 0.002 <0.001 <0.001 <0.001
This table presents the descriptive statistics. COC is the average of the four implied cost of equity capital measures, calculated using four
implementations of the Ohlson (1995) residual income valuation model, in other words, those of Gebhardt et al. (2001), Claus and Thomas
(2001), Easton (2004), and Gode and Mohanram (2003). I refer to these estimates as rgls, rct, rmpeg and rgm, respectively. N_CFF denotes the
natural logarithm of one plus the number of analysts who issue both cash flow and earnings forecasts. LTG is measured as the difference between
the 2-year-ahead consensus EPS forecast and the 1-year-ahead consensus EPS forecast scaled by the 1-year-ahead consensus EPS forecast.
LNDISP is calculated as the natural logarithm of the coefficient of variation in year t earnings forecasts issued in June. lnMV is the natural
logarithm of market value of equity. MB is the ratio of market to book values. BETA is the systematic risk, estimated using 60 monthly return
data. M_Acc is the absolute of the difference of net income before extraordinary items and operating cash flows, deflated by total assets. Acc_H
reflects the extent to which a firm’s accounting choice is comparable to its industry peers. Each firm is assigned a value of one whenever its
accounting choice is different from most frequently chosen accounting method of its industry group, for each of the following accounting choices:
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(i) inventory valuation, (ii) investment tax credit, (iii) depreciation, (iv) successful efforts vs. full cost for companies with extraction activities and
(v) purchase vs. pooling. Acc_H is estimated as the total assigned scores for each firm scaled by the number of accounting choices in the industry.
EarnVal is calculated as standard deviation of earnings per share before extraordinary items scaled by beginning stock price, scaled by its mean
(*1/1000). Cap_Int is the ratio of gross property, plant and equipment to sales revenue. Altman Z is 1.2 (Net working capital/Total assets) + 1.4
(Retained earnings/Total assets) + 3.3 (Earnings before interest and taxes/Total assets) + 0.6 (Market value of equity/Book value of liabilities) +
1.0 (Sales/Total assets) (Altman 1968). Neg_R is a dummy variable set equal to 1 for firms with negative return and 0 otherwise. Loss is a dummy
variable set equal to 1 for firms with negative earnings and 0 otherwise. N_SF denotes the natural logarithm of one plus the number of analysts
who issue sales forecasts. N_RF denotes the natural logarithm of one plus the number of analysts who issue ROA forecasts. N_EF denotes the
natural logarithm of one plus the number of analysts who issue earnings forecasts.
837
Table 2
838
Firm characteristics and cash analyst coverage
Logit regression of cash analyst coverage
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

Cost of equity capital rgls rct rmpeg rgm COC
© 2015 AFAANZ
Constant 3.321*** 4.394*** 3.643*** 4.175*** 3.839*** 3.929***
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
Cost of Equity Capital 5.284*** 0.266 3.225*** 1.396** 1.802***
(0.000) (0.355) (0.000) (0.025) (0.002)
lnMV 0.398*** 0.463*** 0.437*** 0.462*** 0.445*** 0.451***
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
M_Acc 2.200*** 2.048*** 2.030*** 2.136*** 2.071*** 2.078***
(0.000) (0.000) (0.001) (0.000) (0.000) (0.000)
Acc_H 0.071 0.199 0.073 0.009 0.034 0.045
(0.731) (0.345) (0.726) (0.966) (0.870) (0.828)
EarnVal 3.298 1.536 2.619 1.727 2.284 2.175
(0.331) (0.658) (0.444) (0.617) (0.505) (0.526)
Cap_Int 0.307*** 0.332*** 0.305*** 0.311*** 0.306*** 0.308***
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
Altman 0.047*** 0.031*** 0.034*** 0.031*** 0.033*** 0.033***
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
MB 0.040*** 0.048*** 0.045*** 0.047*** 0.047***
(0.000) (0.000) (0.000) (0.000) (0.000)
Neg_R 0.189*** 0.201*** 0.191*** 0.197*** 0.197***
(0.003) (0.001) (0.002) (0.002) (0.002)
Loss 0.147 0.203* 0.136 0.180* 0.164

(0.167) (0.056) (0.203) (0.091) (0.124)
Pseudo-R2 0.111 0.121 0.116 0.120 0.117 0.117
N 5,001 5,001 5,001 5,001 5,001 5,001
This table examines whether firm characteristics and the cost of equity capital measures affect cash analyst coverage. The dependent variable is a
dummy variable that takes a value of one if a firm has cash analyst coverage, and 0 otherwise. See Table 1 for the variable definitions.
magnitude of correlations is consistent with that of prior studies (e.g. Dhaliwal

et al., 2006).
To the extent that analysts issue cash flow forecasts to address investors’
information needs, they are likely to focus on large firms because the demand
for analysts’ research is great in large firms, where investors make more profits
from a piece of information (Bhushan, 1989a,b). The demand hypothesis also
predicts that holding firm size constant, cash analyst coverage is high for firms
with higher information risk. Table 2 presents results consistent with this
expectation.11 Model 1, which replicates the results of DeFond and Hung
(2003), shows that there is higher cash analyst coverage for firms with large size
(lnMV), large accruals (M_Acc), heterogeneous accounting choices relative to
their industry peers (Acc_H), high earnings volatility (Earn_Val), high capital
intensity (Cap_Int) and in more financial distress (Altman).12 These findings
suggest that analysts tend to provide cash flow forecasts for firms where
earnings are less useful in firm valuation and investors’ information needs are
high.
In addition, the evidence in Model 2–6 of Table 2 shows that analysts tend to
issue cash flow forecasts for financially distressed firms, such as firms with low
Altman’s Z-score values (Altman), low market valuation (MB), negative
returns (Neg_R) and losses (Loss). This finding suggests that analysts’ decisions
to issue cash flow forecasts are not entirely influenced by economic incentives.
Following well-performing firms generally leads to greater commission
revenues (e.g. McNichols and O’Brien, 1997). Accordingly, if analysts take
into account immediate economic benefits, they would likely give up coverage
of financially distressed firms for coverage of well-performing firms rather than
devote their limited research resources to providing supplementary information
(i.e. cash flow forecasts) for financially distressed firms.
The evidence in Model 2–6 of Table 2 also reports that firms with high cost
of equity capital generally have higher cash analyst coverage. This is consistent
with the findings as presented above because firms with high information risk
and financial distress generally have a higher cost of equity capital. It follows
that the potential bias from endogeneity works against finding a negative
association between cash analyst coverage and the cost of equity capital.
However, I cannot entirely rule out the possibility that potential bias from
endogeneity contributes to my results because analysts may tend to cover
stocks whose cost of equity capital is expected to decrease even though the
current level of a firm’s cost of equity capital is high.
To examine whether cash analyst coverage reduces the cost of equity capital,
I estimate Equation (1) as discussed earlier. Table 3 presents the regression
11
The dependent variable is a dummy variable that takes a value of one if a firm has
cash analyst coverage and 0 otherwise.
12
Following DeFond and Hung (2003), I do not control for industry effects.
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Table 3
The effect of cash analyst coverage on the cost of equity capital
Dependent Model 1 Model 2 Model 3 Model 4 Model 5

variable rgls rct rmpeg rgm COC
Constant 0.146*** 0.144*** 0.144*** 0.139*** 0.142***

(0.000) (0.000) (0.000) (0.000) (0.000)
N_CFF 0.005*** 0.004 0.003** 0.003** 0.004**
(0.000) (0.132) (0.028) (0.048) (0.013)
LTG 0.006*** 0.079*** 0.023*** 0.024*** 0.034***
(0.000) (0.000) (0.000) (0.000) (0.000)
LNDISP 0.112*** 0.226*** 0.140*** 0.132*** 0.149***
(0.000) (0.002) (0.000) (0.000) (0.000)
lnMV 0.004*** 0.005** 0.004*** 0.004*** 0.004***
(0.000) (0.033) (0.002) (0.002) (0.002)
MB 0.002*** 0.000 0.001* 0.001 0.001**
(0.000) (0.919) (0.092) (0.167) (0.043)
BETA 0.005** 0.009* 0.009*** 0.009*** 0.008***
(0.020) (0.083) (0.000) (0.000) (0.002)
M_Acc 0.007 0.005 0.031* 0.032* 0.012
(0.467) (0.847) (0.089) (0.085) (0.489)
Acc_H 0.015*** 0.014 0.009 0.010* 0.002
(0.001) (0.207) (0.106) (0.080) (0.674)
EarnVal 0.165* 0.248 0.266*** 0.256*** 0.231**
(0.088) (0.102) (0.004) (0.003) (0.015)
Cap_Int 0.002** 0.003 0.003** 0.003** 0.002**
(0.026) (0.169) (0.029) (0.020) (0.034)
Altman 0.001*** 0.001*** 0.001*** 0.001*** 0.001***
(0.000) (0.001) (0.000) (0.000) (0.000)
Neg_R 0.001 0.001 0.001 0.001 0.001
(0.280) (0.601) (0.227) (0.237) (0.199)
Loss 0.005** 0.007 0.011*** 0.011*** 0.009***
(0.022) (0.329) (0.000) (0.000) (0.006)
N_SF 0.005*** 0.006* 0.001 0.002 0.001
(0.002) (0.065) (0.517) (0.335) (0.656)
N_RF 0.002 0.009*** 0.005** 0.005** 0.005***
(0.347) (0.002) (0.014) (0.025) (0.008)
N_EF 0.004* 0.011** 0.005** 0.005* 0.007***
(0.079) (0.011) (0.037) (0.059) (0.010)
Year indicators Included
Industry indicators Included
R2 0.406 0.533 0.442 0.441 0.537
N 5,001 5,001 5,001 5,001 5,001
This table presents the regression results for the association between cash analyst coverage
and the cost of equity capital. rgls, rct, rmpeg, rgm and COC are the cost of equity capital
measures described in section 3.2. N_CFF denotes the natural logarithm of one plus the
number of analysts who issue both cash flow and earnings forecasts. See Table 1 for the
definitions of other variables. The numbers in the parentheses are p-values. *, ** and ***
denote significance at the 10, 5 and 1 percent levels, respectively.
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results. The evidence shows that the coefficients on N_CFF are negative and
statistically significant for all cost of equity measures except for rct, suggesting
that all other things equal, the cost of equity capital decreases with the amount
of cash analyst coverage. In terms of economic significance, the estimated
coefficients imply that a one-standard-deviation increase in N_CFF decreases
the cost of equity capital by from 28 to 46 basis points depending on the cost of
equity capital construct. Collectively, these findings corroborate the notion that
analysts’ cash flow forecasts contain high-quality information and can increase
the fraction of and the quality of public information.
The results for control variables are consistent with those in previous
research. The coefficients on LTG and LNDISP are significant and positive,
and the coefficients on lnMV and MB are negative and generally significant
(Fama and French, 1992; Gebhardt et al., 2001; Gode and Mohanram, 2003;
Dhaliwal et al., 2006). Firms with high systematic risk (BETA) have higher
cost of equity capital. Firms with high earnings volatility (EarnVal) and
financial distress (Altman) have higher cost of equity capital, which is
consistent with the notion that earnings of such firms are less useful in firm
valuation (DeFond and Hung, 2003) and thus investors demand risk premiums
for the information risk.13 Firms with losses have higher cost of equity capital.
The results on N_SF are mixed, and the coefficients on N_RF are positive and
generally significant. These results may be attributable to the fact that a failure
to control for the determinants of sales (or ROA) forecasts, due to a lack of
related literature, leads to sales (or ROA) analyst coverage capturing its
determinants. The reason why I include these variables in my regression model
is to control for as many effects that these variables capture as possible, not to
examine the effects of these variables on the cost of equity capital. Unlike the
case with cash analysts, I fail to find that analysts who issue the other
forecasted items, that is, sales and ROA forecasts, focus on firms with high cost
of equity capital and financial distress (untabulated), which is not consistent
with the demand hypothesis.14 I find that analyst coverage (N_EF) is negatively
13
It is also possible that EarnVal and Altman capture firm risks other than information
risk.
14
Cash flow forecast information summarises firms’ overall operations and thus differs
from sales forecasts in terms of information characteristics. In addition, whereas cash-
flow forecast information provides information regarding disaggregated earnings (i.e.
cash flows and accruals), sales and ROA forecasts do not. In particular, ROA forecasts
are less likely to have substantial information content, as ROA forecasts, which are
estimated as earnings forecasts divided by assets, are not expected to have incremental
information content beyond earnings forecasts. Moreover, I find that the average
number of analysts with ROA forecasts is very small (the mean of N_RF (Raw) is 0.613,
see Table 1). Considering that the forecast of any one analyst has low precision and the
information content increases with the amount of analyst coverage (Lys and Soo, 1995;
Easley and O’Hara, 2004), ROA forecasts likely have few of information effects.
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associated with the cost of equity capital (e.g. Easley and O’Hara, 2004; Bowen
et al., 2008).15
5. Additional analyses
5.1. Change analysis
I examine whether firms with high cash analyst coverage experience a

decrease in the cost of equity capital. Specifically, I regress the change in the
cost of equity capital on the level of cash analyst coverage. Table 4 shows that
cash analyst coverage is negatively associated with the change in the cost of
equity capital. This is consistent with other results in this study and
corroborates the view that cash analyst coverage reduces the cost of equity
capital.
5.2. The effect of exogenous decreases in cash analyst coverage
According to the demand hypothesis, analysts begin to provide cash flow

forecasts when investors’ information needs increase and drop coverage
when information needs decrease. This is consistent with DeFond and
Hung’s (2003) evidence that many firms experience ‘initiations’ and
‘breaks’ in the cash flow forecasts. To the extent that analysts’ cash flow
forecasts are useful in reducing the cost of equity capital, the demand
hypothesis predicts that the initiation of cash analyst coverage leads to a
decrease in the cost of equity capital. However, a drop of coverage does
not necessarily lead to an increase in the cost of equity capital. This is
because the drop of coverage may be driven by a decrease in information
needs. However, if a decrease in cash analyst coverage occurs due to
exogenous shocks, such as size reduction in brokerage houses, not due to a
decrease in information needs, it should lead to an increase in the cost of
equity capital.
To examine this conjecture and address endogeneity concerns, I use the 2SLS
test by adopting an instrument to capture decreases in analyst coverage that are
exogenous to firms’ cost of equity capital. Yu (2008) provides a good research
setting for this analysis, as the instrumental variable that he uses captures
exogenous decreases (Yu, 2008; Anantharaman and Zhang, 2011). Specifically,
following Yu (2008), I estimate the following 2SLS regressions using as the
instrumental variable the change in coverage driven by the change in size of
brokerage houses (ExpectedCoverage):
15
This study’s results are robust to using as a proxy for cash analyst coverage an
indicator variable that is set to 1 for firms with at least one cash flow forecast, and 0
otherwise.
© 2015 AFAANZ
Table 4
Change analysis
Dependent Model 1 Model 2 Model 3 Model 4 Model 5

variable Drgls Drct Drmpeg Drgm DCOC
Constant 0.002 0.013 0.001 0.000 0.003

(0.483) (0.130) (0.723) (0.969) (0.512)
N_CFF 0.000 0.005*** 0.002** 0.002** 0.002**
(0.914) (0.010) (0.041) (0.030) (0.016)
LTG 0.003*** 0.050*** 0.016*** 0.017*** 0.021***
(0.000) (0.000) (0.000) (0.000) (0.000)
LNDISP 0.013*** 0.016 0.022*** 0.024*** 0.009
(0.000) (0.223) (0.000) (0.000) (0.128)
lnMV 0.001** 0.004*** 0.001*** 0.001*** 0.002***
(0.037) (0.005) (0.008) (0.010) (0.001)
MB 0.000 0.000 0.000 0.000 0.000
(0.195) (0.678) (0.320) (0.285) (0.360)
BETA 0.000 0.006** 0.000 0.000 0.002
(0.882) (0.013) (0.933) (0.990) (0.171)
M_Acc 0.008 0.032 0.007 0.005 0.014
(0.276) (0.211) (0.546) (0.655) (0.251)
Acc_H 0.004 0.033*** 0.011*** 0.012*** 0.015***
(0.161) (0.000) (0.004) (0.002) (0.000)
EarnVal 0.001 0.085 0.009 0.009 0.028
(0.982) (0.561) (0.888) (0.894) (0.681)
Cap_Int 0.001* 0.003** 0.001** 0.001** 0.002***
(0.061) (0.020) (0.025) (0.036) (0.010)
Altman 0.000*** 0.000 0.000 0.000 0.000
(0.000) (0.937) (0.425) (0.717) (0.405)
Neg_R 0.005*** 0.011*** 0.006*** 0.006*** 0.007***
(0.000) (0.000) (0.000) (0.000) (0.000)
Loss 0.003** 0.038*** 0.013*** 0.015*** 0.019***
(0.013) (0.000) (0.000) (0.000) (0.000)
N_SF 0.001** 0.000 0.001 0.002** 0.001
(0.020) (0.976) (0.103) (0.016) (0.169)
N_RF 0.002** 0.000 0.001 0.001 0.000
(0.039) (0.896) (0.620) (0.699) (0.745)
N_EF 0.002** 0.002 0.004** 0.004*** 0.003*
(0.031) (0.569) (0.011) (0.006) (0.055)
R2 0.034 0.161 0.112 0.117 0.155
N 4,222 4,222 4,222 4,222 4,222
This table presents the results of regressing the change in the cost of equity capital on the level
of cash analyst coverage. See Table 1 for the variable definitions. The numbers in the
parentheses are p-values. *, ** and *** denote significance at the 10, 5 and 1 percent levels,
respectively.
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CCi;t ¼ b0 þ b1 N CFFi;t þ b2 Controlsi;t þ ei;t

N CFFi;t ¼ b0 þ b1 ExpectedCoveragei;t þ b2 Controlsi;t þ li;t
ð2Þ
Xn
ExpectedCoverageit ¼ ExpectedCoverageitj
j¼1

ExpectedCoverageitj ¼ Brokersizejt =Brokersizej0 Coveragej 0
where CC is one of my five proxies for the cost of equity capital (rgls, rct, rmpeg,
rgm or COC). N_CFF is the natural logarithm of one plus the number of
analysts who issue both cash flow and earnings forecasts. ExpectedCoverageit is
the expected coverage of firm i in year t. ExpectedCoverageitj is the expected
coverage of firm i from broker j in year t. BrokerSizejt and BrokerSizej0 are the
number of analysts employed by broker j in year t and year 0, respectively.
Coveragei0 is the size of the coverage of firm i in year 0.
The 2SLS results are reported in Table 5. The first column reports the result
of the first-stage regression. As expected, the instrumental variable (Expect-
edCoverage) is positively associated with cash analyst coverage (N_CFF). The
instrument used in this analysis is powerful and relevant. Specifically, the
Stock-Yogo weak instruments test statistic (Stock and Yogo, 2005)16 is higher
than the conventional thresholds for weak identification with an F-statistic of
19.134.17 The next columns report the results of the second-stage regressions
and show that the coefficients on N_CFF (instrumented) are significantly
negative. These findings are consistent with the results in Table 4 that a
decrease in cash analyst coverage leads to an increase in the cost of equity
capital.
5.3. Intertemporal change analyses
I conduct intertemporal change analyses using a difference-in-differences

design. A difference-in-differences estimation circumvents many of the endo-
geneity problems that typically arise when making comparisons between
heterogeneous observations (Meyer, 1995). A difference-in-differences estima-
tion consists of identifying a specific intervention and comparing the difference
in outcomes before and after the intervention for treatment groups with the
difference for control groups.
16
The test statistic is the F-statistic form of the Cragg and Donald (1993) statistic. The
null hypothesis being tested is that the estimator is weakly identified and rejection of the
null hypothesis represents the absence of a weak-instruments problem.
17
Critical values are 10 percent: 16.38, 15 percent: 8.96, 20 percent: 6.66 and 25 percent:
5.53.
© 2015 AFAANZ
Table 5
The effect of exogenous changes in cash analyst coverage
Model 1 Model 2 Model 3 Model 4 Model 5

Dependent variable N_CFF rgls rct rmpeg rgm COC
Constant 0.468 0.070*** 0.078** 0.080*** 0.084*** 0.077***
© 2015 AFAANZ
(0.336) (0.000) (0.037) (0.000) (0.000) (0.000)
ExpectedCoverage 0.013***
(0.000)
N_CFF (instrumented) 0.089*** 0.081*** 0.080*** 0.073*** 0.081***
(0.000) (0.010) (0.000) (0.000) (0.000)
LTG 0.010 0.007*** 0.078*** 0.024*** 0.025*** 0.034***
(0.329) (0.000) (0.000) (0.000) (0.000) (0.000)
LNDISP 0.135* 0.128*** 0.246*** 0.160*** 0.151*** 0.167***
(0.081) (0.000) (0.000) (0.000) (0.000) (0.000)
lnMV 0.009 0.003*** 0.003** 0.003*** 0.003*** 0.003***
(0.301) (0.000) (0.030) (0.000) (0.000) (0.000)
MB 0.012*** 0.003*** 0.001 0.001*** 0.001*** 0.002***
(0.000) (0.000) (0.255) (0.000) (0.000) (0.000)
BETA 0.046*** 0.001 0.004 0.005*** 0.006*** 0.004**
(0.006) (0.605) (0.255) (0.003) (0.001) (0.033)
M_Acc 0.020 0.004 0.013 0.037** 0.037** 0.023
(0.896) (0.728) (0.634) (0.017) (0.016) (0.138)
Acc_H 0.345*** 0.013** 0.009 0.039*** 0.037*** 0.025***
(0.000) (0.018) (0.494) (0.000) (0.000) (0.000)
EarnVal 0.610* 0.277*** 0.426*** 0.370*** 0.346*** 0.354***
(0.076) (0.000) (0.001) (0.000) (0.000) (0.000)

Cap_Int 0.068*** 0.002** 0.001 0.002 0.002 0.002
(0.000) (0.040) (0.673) (0.126) (0.220) (0.155)
Altman Z 0.010*** 0.001*** 0.002*** 0.001*** 0.001*** 0.002***
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
(continued)
845
846
Table 5 (continued)
© 2015 AFAANZ
Dependent variable N_CFF rgls rct rmpeg rgm COC
Neg_R 0.007 0.000 0.004 0.001 0.001 0.002

(0.647) (0.699) (0.131) (0.268) (0.266) (0.188)
Loss 0.038 0.001 0.001 0.006** 0.007** 0.003
(0.166) (0.797) (0.911) (0.041) (0.026) (0.300)
N_SF 0.050** 0.010*** 0.001 0.003 0.002 0.004**
(0.012) (0.000) (0.846) (0.128) (0.304) (0.025)
N_RF 0.204*** 0.018*** 0.025*** 0.021*** 0.019*** 0.021***
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
N_EF 0.302*** 0.006 0.006 0.001 0.001 0.000
(0.000) (0.123) (0.480) (0.890) (0.867) (0.950)
R2 0.739 0.408 0.512 0.446 0.439 0.524
N 4,151 4,151 4,151 4,151 4,151 4,151
This table presents the 2SLS results. rgls, rct, rmpeg, rgm and COC are the cost of equity capital measures described in section 3.2. N_CFF denotes
the natural logarithm of one plus the number of analysts who issue both cash flow and earnings forecasts. ExpectedCoverage is the instrumental
variable that captures the change in coverage driven by the change in size of brokerage houses (Yu, 2008). See Table 1 for the definitions of other
variables. The numbers in the parentheses are p-values. *, ** and *** denote significance at the 10, 5 and 1 percent levels, respectively.
In this study, the intervention is the initiation of cash analyst coverage. The
treatment group (TREAT) consists of all observations in the 5 years prior to
the year of initiation and all observations in the initial and subsequent
4 years.18 The control group is identified using a propensity-score matching
procedure (e.g. Rosenbaum and Rubin, 1983; McInnis and Collins, 2011). For
each initial firm-year observation in my treatment sample firms, I select a
matching firm (without a cash flow forecast) that has the closest propensity
score in the same year. This propensity score is the predicted value from a logit
regression of a binary variable indicating whether firms have cash flow
forecasts on the determinants identified by DeFond and Hung (2003).19,20 The
observations in the 5 years around the year when a matching firm is selected
comprise my control group.21 I then compare the intertemporal change in the
cost of equity capital before and after the initiation for treatment group
(TREAT) with the intertemporal change for my control group. My difference-
in-differences design is specified in Equation (3).
CCi;t ¼ b0 þ b1 PostCFi;t þ b2 TREATi;t þ b3 PostCFi;t TREATi;t þ b4 LTGi;t

þ b5 LNDISPi;t þ b6 lnMVi;t þ b7 MBi;t þ b8 BETAi;t þ b9 M Acci;t
þ b10 Acc Hi;t þ b11 Earn Vali;t þ b12 Cap Inti;t þ b13 Altmani;t
þ b14 Neg Ri;t þ b15 Lossi;t þ b16 N SFi;t þ b17 N RFi;t þ b18 N RFi;t
þ InteractiontermsbetweencontrolsandTREAT þ ei;t
ð3Þ
where PostCF is an indicator variable set to one if an observation belongs to

the post-cash-flow forecast period either in the treatment sample or in the
control sample, and zero otherwise. TREAT is an indicator variable set to one
if the observation belongs to the treatment sample, and zero otherwise.22
18
The subsequent 4 years should meet the requirement that at least one cash flow
forecast exists in each of these subsequent years.
19
DeFond and Hung (2003) identify six determinants of analyst cash flow forecast:
magnitude of accruals (M_Acc), comparability of accounting choices (Acc_H), earnings
volatility (EarnVal), capital intensity (Cap_Int), financial distress (Altman) and firm size
(lnMV).
20
Specifically, the coefficients are 0.917 (p-value 0.000), 0.893 (p-value 0.000), 0.005 (p-
value 0.002), 0.289 (p-value 0.000), 0.051 (p-value 0.000) and 0.724 (p-value 0.000) for
M_Acc, Acc_H, EarnVal, Cap_Int, Altman and lnMV, respectively, and Pseudo R2 is
0.447.
21
A matching firm-year is used only once. In addition, matched firms are retained if they
do not have a cash flow forecast in either of the 4 years after the initial matching year.
22
Refer to Table 1 for the definitions of other variables.
© 2015 AFAANZ
Table 6
Intertemporal change analyses using a difference-in-differences design

Dependent variable rgls rct rmpeg rgm COC
Intercept 0.146*** 0.145*** 0.141*** 0.138*** 0.143***

(0.000) (0.000) (0.000) (0.000) (0.000)
PostCF 0.002 0.005 0.005 0.005 0.004
(0.343) (0.446) (0.160) (0.123) (0.213)
TREAT 0.003 0.003 0.005 0.003 0.002
(0.731) (0.894) (0.636) (0.789) (0.862)
PostCF*TREAT 0.013*** 0.008 0.008* 0.008* 0.009*
(0.000) (0.394) (0.085) (0.061) (0.052)
LTG 0.013*** 0.169*** 0.069*** 0.074*** 0.081***
(0.000) (0.000) (0.000) (0.000) (0.000)
LNDISP 0.099*** 0.157** 0.178*** 0.160*** 0.149***
(0.000) (0.032) (0.000) (0.000) (0.000)
lnMV 0.003** 0.004 0.002 0.001 0.003
(0.026) (0.277) (0.344) (0.441) (0.173)
MB 0.004*** 0.002* 0.002*** 0.001** 0.002***
(0.000) (0.093) (0.008) (0.033) (0.001)
BETA 0.008*** 0.014* 0.004 0.004 0.007*
(0.003) (0.070) (0.280) (0.193) (0.052)
M_Acc 0.047 0.041 0.071* 0.069* 0.057
(0.112) (0.571) (0.066) (0.069) (0.155)
Acc_H 0.018** 0.004 0.004 0.002 0.005
(0.030) (0.850) (0.743) (0.872) (0.669)
EarnVal 0.000 0.001 0.000 0.000 0.000
(0.336) (0.141) (0.272) (0.318) (0.152)
Cap_Int 0.004*** 0.003 0.000 0.001 0.002
(0.000) (0.341) (0.905) (0.644) (0.168)
Altman Z 0.001*** 0.001* 0.001*** 0.001*** 0.001***
(0.000) (0.057) (0.000) (0.000) (0.000)
Neg_R 0.002 0.002 0.000 0.000 0.001
(0.315) (0.759) (0.879) (0.945) (0.717)
Loss 0.009 0.021 0.007 0.007 0.001
(0.121) (0.159) (0.304) (0.325) (0.949)
N_SF 0.002 0.010** 0.004* 0.007*** 0.005*
(0.210) (0.042) (0.079) (0.001) (0.052)
N_RF 0.004 0.003 0.012** 0.010** 0.007
(0.347) (0.752) (0.015) (0.032) (0.138)
N_EF 0.009** 0.015* 0.015*** 0.011*** 0.012***
(0.013) (0.091) (0.000) (0.007) (0.006)
LTG*TREAT 0.000 0.002 0.000*** 0.000*** 0.000
(0.529) (0.155) (0.002) (0.007) (0.339)
LNDISP*TREAT 0.068** 0.116* 0.075** 0.074** 0.083**
(0.014) (0.054) (0.011) (0.010) (0.017)
lnMV*TREAT 0.002 0.000 0.002 0.002 0.001
(0.313) (0.983) (0.329) (0.303) (0.532)
(continued)
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Table 6 (continued)

Dependent variable rgls rct rmpeg rgm COC
MB*TREAT 0.001*** 0.000 0.000 0.000 0.000*

(0.000) (0.684) (0.320) (0.453) (0.083)
BETA*TREAT 0.004 0.009 0.002 0.002 0.004
(0.106) (0.196) (0.571) (0.441) (0.221)
M_Acc*TREAT 0.016 0.068 0.030 0.029 0.036
(0.540) (0.214) (0.450) (0.448) (0.289)
Acc_H*TREAT 0.010 0.015 0.009 0.007 0.010
(0.293) (0.609) (0.514) (0.564) (0.464)
EarnVal*TREAT 0.000 0.000 0.000 0.000 0.000
(0.623) (0.405) (0.685) (0.640) (0.492)
Cap_Int*TREAT 0.001 0.001 0.005*** 0.005*** 0.003*
(0.289) (0.845) (0.000) (0.001) (0.060)
Altman Z*TREAT 0.000 0.000** 0.000** 0.000** 0.000**
(0.869) (0.017) (0.018) (0.018) (0.038)
Neg_R*TREAT 0.001 0.001 0.001 0.002 0.001
(0.864) (0.934) (0.788) (0.617) (0.853)
Loss*TREAT 0.007 0.014 0.004 0.004 0.000
(0.331) (0.463) (0.633) (0.629) (0.981)
N_SF*TREAT 0.009*** 0.008 0.004* 0.003 0.006**
(0.000) (0.202) (0.088) (0.153) (0.029)
N_RF*TREAT 0.002 0.001 0.007 0.007 0.004
(0.677) (0.885) (0.123) (0.140) (0.450)
N_EF*TREAT 0.002 0.008 0.005 0.005 0.000
(0.505) (0.473) (0.247) (0.244) (0.977)
Controls Included
R2 0.373 0.431 0.469 0.485 0.488
N 2,001 2,001 2,001 2,001 2,001
This table reports the results from intertemporal change analyses using a difference-in-
differences design. rgls, rct, rmpeg, rgm and COC are the cost of equity capital measures
described in section 3.2. POST is an indicator variable set to one if an observation belongs to
the post-cash-flow forecast period either in the treatment sample or in the control sample, and
0 otherwise. TREAT is an indicator variable set to one if the observation belongs to the
treatment sample, and 0 otherwise. See Table 1 for the definitions of other variables. The
numbers in the parentheses are p-values. *, ** and *** denote significance at the 10, 5 and 1
percent levels, respectively.
The negative coefficient on the interaction term between PostCF and

TREAT (b3) suggests that the intertemporal decreases in the cost of equity
capital for the treatment group are greater than those for the control group.
Table 6 shows that the coefficients on the interaction terms between PostCF
and TREAT are negative and significant at the conventional level except
for rct. The economic significance is such that there is a difference of about
© 2015 AFAANZ
80–130 basis points between firms with no cash analyst coverage and firms
that are followed by more than one cash analyst. These results suggest that
treatment firms exhibit a greater decrease in the cost of equity capital from
pre- to post-cash-flow forecast periods than matched control firms, corrob-
orating the notion that cash analyst coverage causes a reduction in the cost
of equity capital. However, the results are relatively weak. One of the
possible reasons may be that the benchmark of one analyst’s cash flow
forecast may not adequately identify a tipping point where the effect of cash
analyst coverage on the cost of equity capital takes hold. In other words, it
is less likely that the effect of one analyst’s cash flow forecast on the cost of
equity capital is significant. Thus, as an alternative, I also identify the
‘initiation’ as the first year in which N_CFF is equal to or greater than the
sample median (two analysts). The results using this alternative benchmark
(untabulated) are stronger than those in Table 6, suggesting that weak
evidence may be attributable to inadequately identifying the tipping point.23
Specifically, the coefficients on the interaction terms between PostCF and
TREAT are negative and significant in all five models at the 5 or 1 percent
level. This evidence is consistent with Lys and Soo (1995) and Easley and
O’Hara (2004), which show that the forecast of any one analyst has low
precision, but the collective forecast of many analysts is much more
accurate.
5.4. Quasi-natural experiment
To further address endogeneity issues, I use mergers of brokerage houses as a

quasi-natural experiment. The premise of using this setting is that mergers lead
to a reduction in analyst coverage on a stock. If a stock is covered before the
merger by both the bidder and target brokerage houses, one of the redundant
analysts – usually the target analyst – is let go or reallocated to another stock
(Hong and Kacperczyk, 2010).
I identify mergers among brokerage houses that occurred between 1993
and 2009 on the basis of information from the SDC Mergers and
Acquisition database24 and match all the mergers with IBES data (Hong
and Kacperczyk, 2010).25 In constructing a sample of treatment firms, I
drop firms for which the surviving brokerage house no longer provides cash-
flow forecasts after the merger because such a drop of coverage could be
23
In further tests, I find much stronger results when ‘the initiation’ is identified using the
benchmark of three analysts.
24
Inclusion in the sample requires that the target brokerage house belong to the four-
digit SIC code 6211.
25
See Hong and Kacperczyk (2010) for details.
© 2015 AFAANZ
Table 7
Quasi-natural experiment. (A) List of brokerage mergers. (B) Trend in the cost of equity capital
(treatment–control). (C) Changes in cash analyst coverage and the cost of equity capital: difference-
in-differences estimator
Brokerage houses
No of treatment-
Number Bidder Target Merger date control matches
(A)
1 Morgan Stanley Dean Witter Reynolds May. 1997 21
2 Smith Barney Salomon Brothers Nov. 1997 4
3 Paine Webber JC Bradford June. 2000 2
4 Credit Suisse First Donaldson Lufkin and Oct. 2000 10
Boston Jenrette
5 UBS Warburg Paine Webber Dec. 2000 36
Dillon Read
6 Merrill Lynch Petrie Parkman & Co. Dec. 2006 67
7 Wachovia Securities A.G. Edwards & Sons Oct. 2007 99
8 Oppenheimer & CO. CIBC World Markets Jan. 2008 14
(B)
.003
.0025
Diff. in cost of equity capital
.002
.0015
.001
.0005
Year –3 Year –2 Year –1 Year 0 Year 1 Year 2
Cash analyst coverage rgls rct rmpeg rgm COC
(C)
Estimator 1.01*** 0.002*** 0.002** 0.001** 0.001** 0.002**
(Standard errors) (0.297) (0.001) (0.001) (0.000) (0.000) (0.001)
This table reports the results of the difference-in-differences tests on how exogenous shocks to
cash analyst coverage resulting from brokerage house mergers affect the cost of equity capital.
Panel A presents details about the mergers including the parties involved: bidder and target.
Panel B shows the trend in the cost of equity capital for the treatment sample net of the
control group. Panel C shows the test results for changes in cash analyst coverage and the cost
of equity capital. Standard errors (in parentheses) are clustered at the merger groupings.
© 2015 AFAANZ
endogenous (the surviving brokerage house chooses to cease covering the

firm).
I measure the changes in cash analyst coverage and the cost of equity
capital for the stocks in the treatment sample from 1 year before the merger
to 1 year after relative to a control group of stocks, that is, I use the
difference-in-differences methodology. The control group contains stocks
with the same market capitalisation, market-to-book ratio, past return and
analyst coverage features before the merger as the treatment sample.
Specifically, I require that control firms be in the same market capitalisation
tercile, market-to-book ratio tercile, past return tercile and analyst coverage
tercile in the matching year. Thus, the benchmark includes 81 portfolios.
This procedure ensures that the difference between the treatment and control
firms is not driven by their cross-sectional heterogeneity that affects both
groups of firms. Overall, I end up with eight mergers and 253 unique pairs
of treatment–control matches.
Table 7 reports the results of using the brokerage merger sample. In Panel
A, I summarise the names, dates and number of unique pairs of treatment–
control matches. Before reporting the test results, I investigate trends in
the cost of equity capital during the pre-shock period (before the merger) in
Panel B, which depicts the difference in the cost of equity capital
between the treatment and control groups before and after the merger. It
indicates that the difference in the cost of equity capital between the
treatment and control groups is stable in the 3 years leading up to the
merger, suggesting that no trend exists in the pre-period.26 In Panel C, I
present the difference-in-differences estimators for cash analyst coverage and
the cost of equity capital using the benchmarking technique of size, market-
to-book, return and coverage matched.27 First, the results show a drop in
cash analyst coverage of about 1.01 analysts (significant at the 1 percent
level) due to mergers. This decline is consistent with the expectation that
approximately one analyst will be dropped after a merger, which verifies the
premise of the natural experiment. The evidence also shows how the cost of
equity capital changes for the treatment sample net of the control group
across mergers. Using the difference-in-differences estimator, I find an
increase in the cost of equity capital of 10–20 basis points depending on the
cost of equity capital construct (significant at the 1 or 5 percent level).
Overall, the evidence from the quasi-natural experiments alleviates the
endogeneity concern.
26
The level of the cost of equity capital does not need to be identical across the
treatment and control firms over the pre- and post-periods because these distinctions are
differenced out in the estimation.
27
The results are similar when I use benchmarks matched along any subset of the
characteristics.
© 2015 AFAANZ
5.5. Relative forecast accuracy of cash analysts’ long-term earnings forecasts
I explore one of the causes of cash analysts’ significant role in reducing the
cost of equity capital. The cost of equity capital is affected by near- and long-
term uncertainty. The effective role of cash analyst coverage in reducing the
cost of equity capital therefore suggests that cash analysts possess a superior
ability to reduce not only near- but also long-term uncertainty. To corroborate
this interpretation, I investigate the ability of cash analysts to forecast long-
term earnings. Specifically, I investigate whether cash analysts issue more
accurate long-term earnings forecasts, which are useful in reducing long-term
uncertainty, than other analysts using the following Equation (4).28
MFERRi;j;t ¼ b0 þ b1 CashCi;j;t þ b2 l MFERRi;j;t þ b3 MAGEi;j;t

þ b4 MFREQi;j;t þ b5 MGEXPi;t þ b6 MFEXPi;j;t
þ b7 MNCOSi;t þ b8 MNSICi;t þ b9 TOP10i;t ð4Þ
þ Year indicators þ Industry indicators
þ Analyst indicators þ ei;j;t
where MFERRi,j,t is the mean-adjusted long-term earnings forecast error,

defined as the difference between the absolute long-term earnings forecast error
of analyst i for firm j in year t and the mean absolute long-term earnings
forecast error for firm j in year t, scaled by the mean absolute long-term
earnings forecast error for firm j in year t (Clement, 1999; Jacob et al., 1999;
Chen and Matsumoto, 2006; Call et al., 2009)29; CashCi,j,t is CFFi,j,t or
Initiation i,j,t, where CFFi,j,t is an indicator variable that equals one if analyst i
issues both cash flow and earnings forecasts for firm j in year t, and equals zero
if analyst i issues only earnings forecast for firm j in year t and Initiation i,j,t is a
dummy variable that takes a value of one if an analyst i issues at least one cash-
flow forecast in year t for firm j but does not do so in year t1, and 0 in the year
t1; l_MFERRi,j,t is one period lagged MFERR; MAGEi,j,t is the mean-
adjusted number of days between analyst i’s long-term earnings forecast date
and the actual earnings announcement date for firm j in year t; MFERQi,j,t is
the mean-adjusted number of distinct long-term earnings forecasts made by
analyst i for firm j in year t; MGEXPi,t is the mean-adjusted number of years for
which analyst i has supplied at least one earnings forecast prior to year t;
MFEXPi,j,t is the mean-adjusted number of years for which analyst i has
supplied at least one earnings forecast for firm j prior to year t; MNCOSi,t is the
28
I assess the significance of my regression coefficients using standard errors adjusted for
analyst-, firm- and year-level clustering (Petersen, 2009).
29
I use earnings forecasts for the next year (i.e., fpi=2 in I/B/E/S database) as long-term
earnings forecasts.
© 2015 AFAANZ
Table 8
The effect of cash flow forecasts on long-term earnings forecast accuracy
Dependent variable is long-term earnings forecast error
CashC = CFF CashC = Initiation
Intercept 0.054 0.131

(0.676) (0.671)
CashC 0.021*** 0.037**
(0.002) (0.033)
l_MFERR 0.019***
(0.000)
MAGE 4.845*** 4.514***
(0.000) (0.000)
MFREQ 0.014*** 0.014
(0.002) (0.555)
MGEXP 0.012* 0.012
(0.082) (0.784)
MFEXP 0.004 0.009
(0.242) (0.639)
MNCOS 0.044*** 0.063
(0.000) (0.220)
MNSIC 0.005 0.015
(0.403) (0.720)
TOP10 0.017 0.040
(0.123) (0.399)
Analyst indicators Included
Adjusted R2 0.182 0.255
N 105,114 4,136
This table compares the relative long-term earnings forecast accuracy of analysts with and
without cash flow forecasts. CFF denotes a dummy variable which takes a value of one if an
analyst issues both cash flow and earnings forecasts, and 0 if an analyst issues only earnings
forecast. Initiation refers to a dummy variable which takes a value of one if an analyst issues
at least one cash flow forecast in year t but does not do so in year t1, and 0 in the year t1.
See section 5.4 for the definitions of other variables. The numbers in the parentheses are p-
values. *, ** and *** denote significance at the 10, 5 and 1 percent levels, respectively.
mean-adjusted number of distinct firms for which analyst i makes at least one
earnings forecast during year t; MNSICi,t is the mean-adjusted number of
distinct industries (based on two-digit SIC codes) for which analyst i makes at
least one earnings forecast during year t; TOP10i,t is an indicator variable set
equal to 1 if analyst i is employed by a brokerage firm in the top size decile in
year t, and 0 otherwise.
I expect a negative coefficient on CFF, which implies that the long-term
earnings forecasts of analysts who issue both cash flow and earnings forecasts
are more accurate than those of analysts who issue only earnings forecasts. To
© 2015 AFAANZ
Table 9
Cash analyst coverage and information asymmetry
Dependent variable is PIN

Cash analyst coverage N_CFF
Constant 0.293***
(0.000)
Cash_C 0.003**
(0.015)
LTG 0.000
(0.515)
LNDISP 0.018***
(0.001)
lnMV 0.018***
(0.000)
MB 0.000**
(0.023)
BETA 0.010***
(0.000)
M_Acc 0.037***
(0.001)
Acc_H 0.006
(0.147)
EarnVal 0.073
(0.243)
Cap_Int 0.003***
(0.000)
Altman 0.001***
(0.000)
Neg_R 0.001
(0.321)
Loss 0.003*
(0.089)
Sales_C 0.005***
(0.000)
ROA_C 0.005***
(0.004)
N_EF 0.013***
(0.000)
R2 0.645
N 4,785
This table presents the regression results for the association between cash analyst coverage
and information asymmetry measured as probability of informed trading (Brown et al.,
2004). N_CFF denotes the natural logarithm of one plus the number of analysts who issue
both cash flow and earnings forecasts. See Table 1 for the definitions of other variables. The
numbers in the parentheses are p-values. *, ** and *** denote significance at the 10, 5 and 1
percent levels, respectively.
© 2015 AFAANZ
further examine the association between cash flow forecasts and long-term
earnings forecast accuracy, I also investigate whether long-term earnings
forecast accuracy changes after the initiation (Initiation) of cash flow forecasts
(e.g. Call et al., 2009; Keung, 2010). In other words, I examine whether the
same analyst’s long-term earnings forecast accuracy for the same firm changes
after the initiation of cash flow forecasts (Keung, 2010).
Table 8 shows that the coefficient on CFF is significantly negative (coefficient
0.021, p-value. 0.002). This evidence suggests that the long-term forecast
accuracy of cash analysts is higher than that of analysts who issue only earnings
forecasts. The results also show that the coefficient on Initiationi,j,t is
significantly negative (coefficient 0.037, p-value. 0.033), suggesting that an
analyst’s long-term earnings forecast accuracy for a firm is higher for the year
in which the analyst issues a cash flow forecast than it is for the year in which
the analyst does not. Collectively, these findings, along with the evidence that
short-term earnings forecasts are more accurate in the presence of cash flow
forecasts (Call et al., 2009), corroborate the notion that cash analysts reduce
not only near- but also long-term uncertainty and thereby significantly
contribute to a reduction in the cost of equity capital.30
5.6. Cash analyst coverage and information asymmetry
I measure information asymmetry as PIN, which is the probability of

informed trading (Brown et al., 2004) and examine the association between
cash analyst coverage and PIN. Table 9 provides the results. The coefficient on
cash analyst coverage is negative and significant at more than the 5 percent
level. This suggests that cash analyst coverage reduces information asymmetry
and that one of the links between cash flow forecasts and the cost of equity
capital is the contribution of cash analyst coverage to a reduction in
information asymmetry.
6. Conclusion
Analysts are subject to a number of well-known conflict of interests that can

result in biased or inaccurate forecasts. This raises a doubt as to whether
30
This study and Call et al. (2009) focus on relative forecast accuracy. DeFond and
Hung (2003) find that analysts tend to provide cash flow forecasts for firms with large
accruals, heterogeneous accounting choices relative to their industry peers, highly
volatile earnings, high capital intensity and financial distress. Such firms generally have
less predictable earnings. Thus, to examine whether analysts’ earnings forecasts are more
accurate when analysts also issue cash flow forecasts, controlling for the varying degree
of forecasting difficulty across firms and years is important (Clement, 1999; Jacob et al.,
1999; Chen and Matsumoto, 2006; Call et al., 2009). The results show that cash analysts
provide more accurate earnings forecasts than other analysts who follow the same firm
in the same year.
© 2015 AFAANZ
analysts can significantly contribute to a firm’s information environment.

However, it is unlikely that analysts focus only on pursuing immediate
economic benefits, because simply doing so hurts their reputation and they
cannot obtain any economic benefits without an established reputation. In
other words, pursuing only immediate economic benefits is undoubtedly
detrimental to their long-term economic performance and building a positive
reputation can be regarded as long-term investments designed to provide future
economic benefits. Thus, it is a reasonable assumption to say that even though
analysts behave opportunistically from time to time, they also have incentives
to provide useful information in response to investors’ information needs.
Consistent with this view, this study documents that analyst issue cash flow
forecasts, which are useful in reducing the cost of equity capital. This suggests
that analysts can play a significant role as information intermediaries and
provides an explanation for why analysts have occupied an important position
in capital markets as price setters.
I acknowledge that the results of this study may suffer from endogeneity bias.
I address this issue by conducting the difference-in-differences analysis, the
2SLS test adopting an instrument to capture the variations in analyst coverage
that are exogenous to firms’ cost of equity capital, and the test of the effect of
an exogenous reduction in cash analyst coverage resulting from brokerage
house mergers on the cost of equity capital and find that the results do not seem
to be driven by an endogenous relation. However, I do not entirely rule out the
possibility that the potential bias from endogeneity or omitted correlated
variables would contribute to my regression results.
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Accounting and Finance 55 (2015) 825–859

Are analysts’ cash ﬂow forecasts useful?

Sung Hwan Jung

JEL classiﬁcation: G24, G30

This paper is based on my dissertation at Korea University. I am grateful to Steven

difference-in-differences specifications), subsamples, and different measures of

2. Related research and hypothesis development

2.1. Information intermediary and cost of equity capital

role in the acquisition and dissemination of information in capital markets, and

2.2. Analysts’ cash ﬂow forecasts and cost of equity capital

that the quality of public information increases, as cash analyst coverage

3. Sample selection and methodology

3.2. Measurement of the implied cost of equity capital

3.3. Model speciﬁcation

To test my hypothesis, I estimate the following Equation (1)6 :

CCi;t ¼ b0 þ b1 Cash Ci;t1 þ b2 LTGi;t þ b3 LNDISPi;t þ b4 lnMVi;t þ b5 MBi;t

in meeting investors’ information needs, I expect a negative coeﬃcient on cash

Variable N Mean SD 25% 50% 75%

N_SF (raw) 5,001 7.355 8.218 1.000 5.000 11.000

Variable N Mean SD 25% 50% 75%

N_EF 5,001 2.718 0.580 2.398 2.773 3.135

Firm characteristics and cash analyst coverage

Logit regression of cash analyst coverage

Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

Loss 0.147 0.203* 0.136 0.180* 0.164

magnitude of correlations is consistent with that of prior studies (e.g. Dhaliwal

Dependent Model 1 Model 2 Model 3 Model 4 Model 5

Constant 0.146*** 0.144*** 0.144*** 0.139*** 0.142***

5.1. Change analysis

I examine whether ﬁrms with high cash analyst coverage experience a

5.2. The eﬀect of exogenous decreases in cash analyst coverage

According to the demand hypothesis, analysts begin to provide cash ﬂow

Dependent Model 1 Model 2 Model 3 Model 4 Model 5

Constant 0.002 0.013 0.001 0.000 0.003

CCi;t ¼ b0 þ b1 N CFFi;t þ b2 Controlsi;t þ ei;t

5.3. Intertemporal change analyses

I conduct intertemporal change analyses using a diﬀerence-in-diﬀerences

Model 1 Model 2 Model 3 Model 4 Model 5

Constant 0.468 0.070*** 0.078** 0.080*** 0.084*** 0.077***

(0.076) (0.000) (0.001) (0.000) (0.000) (0.000)

Model 1 Model 2 Model 3 Model 4 Model 5

Neg_R 0.007 0.000 0.004 0.001 0.001 0.002

CCi;t ¼ b0 þ b1 PostCFi;t þ b2 TREATi;t þ b3 PostCFi;t TREATi;t þ b4 LTGi;t

where PostCF is an indicator variable set to one if an observation belongs to

Model 1 Model 2 Model 3 Model 4 Model 5

Intercept 0.146*** 0.145*** 0.141*** 0.138*** 0.143***

Model 1 Model 2 Model 3 Model 4 Model 5

MB*TREAT 0.001*** 0.000 0.000 0.000 0.000*

The negative coeﬃcient on the interaction term between PostCF and

5.4. Quasi-natural experiment

To further address endogeneity issues, I use mergers of brokerage houses as a

Year –3 Year –2 Year –1 Year 0 Year 1 Year 2

Cash analyst coverage rgls rct rmpeg rgm COC

endogenous (the surviving brokerage house chooses to cease covering the

5.5. Relative forecast accuracy of cash analysts’ long-term earnings forecasts

MFERRi;j;t ¼ b0 þ b1 CashCi;j;t þ b2 l MFERRi;j;t þ b3 MAGEi;j;t

where MFERRi,j,t is the mean-adjusted long-term earnings forecast error,

Dependent variable is long-term earnings forecast error

CashC = CFF CashC = Initiation

Intercept 0.054 0.131

Dependent variable is PIN

5.6. Cash analyst coverage and information asymmetry

I measure information asymmetry as PIN, which is the probability of

Constant 0.146* 0.144* 0.144* 0.139* 0.142***

Constant 0.468 0.070* 0.078 0.080* 0.084* 0.077***

Intercept 0.146* 0.145* 0.141* 0.138* 0.143***