Evidence that Analyst Following and Institutional Ownership Accelerate the Pricing of Future Earnings

This paper presents evidence that prices of firms followed by sell-side analysts and favored by institutional investors incorporate future earnings earlier than prices of other firms. We conduct two sets of empirical tests: the first examines coefficients from regressions of returns on lead, contemporaneous, and lag earnings changes; the second compares the timing of monthly abnormal returns from earnings-based zero-investment portfolios. In both sets of tests, the results for analysts and institutions are incremental to each other. In addition, neither the analyst price lead nor the institutional price lead is due to price leads increasing with firm size.     

A dynamic analysis of the neglected firm effect

This study uses rolling regressions with panel data and conducts a dynamic analysis of the neglected firm effect, the negative relationship between the number of analysts and stock returns. For this reason, we use two samples of firms: one from the London Stock Exchange (LSE) and another from Bursa Malaysia (BM). The results reveal a significantly negative neglected firm effect only for the BM sample. In contrast the association between the number of analysts and stock returns is positive in some periods in the LSE. Size is not significant as a moderator, which suggests that the neglected firm effect does not vary with firm size, contrary to the findings in the previous literature. Finally, the neglected firm effect is nonstationary for both LSE and BM firms. Our results hold under a range of robustness tests and yield guidelines for investors regarding the types of markets and time periods for which analyst coverage is likely to matter most.     

Stock price synchronicity and analyst coverage in emerging markets

This paper examines the relation between the stock price synchronicity and analyst activity in emerging markets. Contrary to the conventional wisdom that security analysts specialize in the production of firm-specific information, we find that securities which are covered by more analysts incorporate greater (lesser) market-wide (firm-specific) information. Using the R² statistics of the market model as a measure of synchronicity of stock price movement, we find that greater analyst coverage increases stock price synchronicity. Furthermore, after controlling for the influence of firm size on the lead–lag relation, we find that the returns of high analyst-following portfolio lead returns of low analyst-following portfolio more than vice versa. We also find that the aggregate change in the earnings forecasts in a high analyst-following portfolio affects the aggregate returns of the portfolio itself as well as those of the low analyst-following portfolio, whereas the aggregate change in the earnings forecasts of the low analyst-following portfolio have no predictive ability. Finally, when the forecast dispersion is high, the effect of analyst coverage on stock price synchronicity is reduced.     

Do Analysts Influence Corporate Financing and Investment?

We examine whether abnormal analyst coverage influences the external financing and investment decisions of the firm. Controlling for self-selection bias in analysts' excessive coverage, we find that firms with high (low) analyst coverage consistently engage in higher (lower) external financing than do their industry peers of similar size. Our evidence also demonstrates that firms with excessive analyst coverage overinvest and realize lower future returns than do firms with low analyst coverage. Our findings are consistent with the hypothesis that analysts favor the coverage of firms that have the potential to engage in profitable investment-banking business.     

Environmental performance and analyst information processing costs

This study tests whether the information processing costs of analysts vary positively with the environmental performance information available on the firms they follow. Consistent with this conjecture, we find that these costs increase when analysts process a wider array of environmental performance ratings. Specifically we find that as the number of environmental performance ratings increases, analysts cover fewer firms in their portfolio, provide fewer earnings-per-share (EPS) forecast revisions, and make less timely forecast revisions. Two additional tests confirm that our results relate to environmental performance information and not to confounding factors. First, the “shock” of the Global Warming Solutions Act of 2006 implemented for California firms in 2012 increases analyst information processing costs incremental to the main effect of environmental performance ratings. Second, analyst information processing costs increase further in the year a firm covered by an analyst provides a CSR report for the first time. Our results have implications for firm managers considering voluntary environmental disclosure and investors deciding on what stocks to include in their socially responsible portfolios because when processing costs are high, analysts will provide less information or less timely information, resulting in more gradual price discovery in capital markets.     

Analyst Coverage and Intangible Assets

This study examines the relation between analysts' incentives to cover firms and the extent of their intangible assets. Because intangible assets typically are unrecognized and estimates of their fair values are not disclosed, absent analyst coverage firms with more intangible assets likely have less informative prices. Accordingly, we expect analysts have greater incentives to cover firms with more intangible assets and, thus, predict they have higher analyst coverage. As predicted, we find that analyst coverage is significantly greater for firms with larger research and development and advertising expenses relative to their industry, and for firms in industries with larger research and development expense. We also predict and find that analyst coverage is increasing in firm size, growth, trading volume, equity issuance, and perceived mispricing, and is decreasing in the size of the firm's analysts' brokerage houses and the effort analysts expend to follow the firm. These findings indicate that analyst coverage depends on private benefits and costs of covering a firm. We also test hypotheses related to analyst effort. We predict and find that analysts expend greater effort to follow firms with more intangible assets, after controlling for other factors associated with analyst effort. Our evidence indicates that intangible assets, most of which are not recognized in firms' financial statements, are associated with greater incentives for analysts to cover such firms, and greater costs of coverage. An open question is whether financial statement recognition of intangible assets could more efficiently provide information about such assets to investors.     

Are All Security Analysts Equal?

We examine the extent to which security analysts are homogeneous in their effect on firm valuation as measured by Tobin's Q. Earlier research documents a significant and positive relation between analyst coverage and firm valuation. We identify three classes of equity analysts and examine their differential effect on firm valuation associated with their coverage and their information production. We find that equity analysts are not homogeneous in their effect on firm valuation. The presence of analysts at national securities firms have the strongest effect on firm valuation followed by analysts at regional securities firms and finally analysts at nonbrokerage, or research, firms. We attribute this result to the differential monitoring and information dissemination function rendered by the analysts. Information produced by analysts, however, does not share the same credibility. Specifically, we find brokerage firms' buy recommendations are discounted by the market and have a weak effect on firm valuation. The results can be supported by arguments that brokerage firm analysts' recommendations are contaminated by their firms' investment banking relations with corporations.     

Market reactions to the closest peer firm’s analyst revisions

Prior analyst literature focuses on the impact of financial analysts on the firms they cover, and prior information-transfer literature concentrates on the externalities of information provided by management. This paper fills gaps in both streams of literature by examining the focal firm’s market reactions to the closest peer firm’s (identified by product similarity) analyst revisions. We find that the focal firm’s stock price reacts to the closest peer’s analyst revisions made by analysts who are not covering the focal firm. The focal firm’s cumulative abnormal return for a five-day window centered on the revision date is 0.54% higher if the peer firm’s analyst revision magnitude is in the top decile than if it is in the bottom decile. Cross-sectional tests show that the sensitivity of the focal firm’s market reactions to the peer firm’s revisions increases with the revision informativeness and the similarity between the focal firm and the peer firm. In addition, we find that focal firms do not react to peer firms’ revisions in industries with strong competition where the competitive effects cancel out the spillover effects. Finally, we find that the focal firm’s market reactions can predict its own future analyst revisions, suggesting that the reactions are at least partially rational.     

Is Sell‐Side Research More Valuable in Bad Times?

Because uncertainty is high in bad times, investors find it harder to assess firm prospects and hence should value analyst output more. However, higher uncertainty makes analysts’ tasks harder, so it is unclear whether analyst output is more valuable in bad times. We find that in bad times, analyst revisions have a larger stock‐price impact, earnings forecast errors per unit of uncertainty fall, and analyst reports are more frequent and longer. The increased impact of analysts is also more pronounced for harder‐to‐value firms. These results are consistent with analysts working harder and investors relying more on analysts in bad times.     

Can security analyst forecasts predict gold returns?

This paper examines whether security analyst earnings forecasts for firms primarily operating in the gold market can be utilised to predict returns on the price of gold. We first demonstrate that analysts are at least in part basing their earnings forecasts for gold firms on the return expectations of the gold commodity market. We show this by providing evidence that analyst coverage impounds not only market-wide and industry information, but also gold price information for these firms — as measured via its impact on stock return synchronicity. We then examine if the difference between forecast and observed earnings for these firms has predictive value for changes in the price of gold whilst controlling for a number of macroeconomic factors. We find that this difference does hold predictive power, but also has some limitations. However, there is potential for it to be used as an additional variable within gold forecasting frameworks.