Analysts Unchained—Expanded Information Processing Capacity and Effort Transfer under Technology Adoption

Abstract

Analysts acquire and disseminate information to assist investors in equity valuation. Despite their expertise in equity valuation, sell-side analysts are economic agents with limited time and cognitive resources. The constraint on an analyst’s information processing capacity is reflected by the previously documented negative association between an analyst’s forecast accuracy for a focal firm and the total number of firms the analyst covers. While prior research focuses on analysts’ attributes and portfolio firm characteristics as factors impinging on analysts’ information processing capacity, I examine whether information technology—an exogenous factor—can alleviate this constraint. Using the recent exogenous shock of XBRL adoption, I find that the widespread adoption of XBRL expands analysts’ information processing capacity. I document two consequences of this expanded capacity. As an analyst’s information processing capacity increases, the analyst either improvs the forecast accuracy for non-adopting firms in the existing portfolio or increases the size of the portfolio. This finding indicates that the adoption of XBRL generates a positive externality from the adopting firms due to the transfer of analyst effort away from those firms. This study provides the first evidence that exogenous factors such as the adoption of new technology can expand analysts’ information processing capacity, thereby allowing analysts to improve the overall quality of existing coverage and allowing more firms to enjoy the benefits of analyst coverage. The paper also provides the new insight that information externalities can exist among firms that are fundamentally unrelated by identifying another channel—the effort channel—as a source of such externalities.