Learning and incentive: A study on analyst response to pension underfunding

There is a long-standing debate on whether sell-side analysts learn from their experience to improve earnings forecast skills. This study shows that incentive is an important factor for understanding the “learning by doing” effect by analysts. We examine analysts' response to a complex type of information - corporate pension underfunding. Pension underfunding negatively impacts future earnings and analysts on average underreact to such information in their earnings forecasts. More importantly, when there is a strong incentive for analysts to deliver accurate forecasts, analyst learning effectively reduces their underreaction to pension underfunding information. On the other hand, when such an incentive is absent, the analyst learning effect is not discernible in the data. Further evidence suggests that analyst learning and incentive jointly reduce stock market mispricing associated with corporate pension underfunding.