Essays on Sell-Side Analysts

Abstract

Broadly, this study focuses on roles of sell-side analysts and examines the determinants and consequences of information discovery and stock timing roles by sell-side analysts. We also re-examine reiterations of prior recommendations by sell-side analysts. In Chapter 1, the contribution is to document that analysts add value by engaging in discovery of private information and this value addition is greater than that due to interpretation of public news or stock timing. The innovation in this Chapter is to read over 3,700 analyst reports from Investext and explicitly identify whether the report contains discovery, interpretation, and/or timing. Analysts discover new information by talking to management sources (personal meetings, investor meetings, and conference calls) or non-management sources (such as channel checks). We find that information discovery is prevalent in 17% of the reports. The cumulative abnormal return (CAR) for reports containing discovery are 6.3% for upgrades and -10.6% for downgrades. The CARs are higher for reports containing discovery relative to those containing interpretation or timing. We find that economic determinants predict whether a report will contain discovery. Discovery from management sources is more likely for reports in the pre-Reg FD period and for reports by optimistic analysts. Discovery from non-management sources is more likely for reports written by All-Star analysts, and for firms that have high information asymmetry and those that are followed by more analysts. In Chapter 2, the contribution is to introduce and document a third role that analysts play that is also valuable to investors, which we term "stock timing." Specifically, we define a timing report as one where the analyst revises his recommendation but does not revise the Price Target or any of the 23 fundamental drivers of stock price (such as EPS, FCF) tracked by I/B/E/S. Because the analyst maintains the same price target as in his prior report but still revises his recommendation, such timing calls are contrarian valuation calls. Analysts issue timing downgrades (upgrades) in response to price increases (declines) since the release of their prior report on the firm. 30% of all revisions are timing reports, indicating the importance of the timing role played by analysts. If analysts have timing ability, then markets should react to the release of the timing report and we should observe that economic determinants explain the cross-sectional variation in timing ability. We find the 3-day announcement return is over 2% in magnitude, 62% of the reports are winners (have announcement returns that have the correct sign), 10% of the reports are large enough to be considered influential, and 37% of the reports are persistent winners. These results suggest that analysts have timing ability. The ability to time is similar is magnitude to information interpretation but smaller compared to information discovery. We find considerable cross-sectional and time-series variation in timing ability. We find that the probability of issuing a timing report is positively related to the opportunities to time the stock provided by potential mispricing. Conditional on issuing a timing report, the probability of issuing a winner, an influential winner, or a persistent winner is positively related to analyst experience and negatively related to the costs associated with issuing a timing report. In Chapter 3, we document that recommendation reiterations are not homogeneous and there is a large subset of reiterations that are as much valued by investors as recommendation revisions. We combine Detail History file containing the measures tracked by I/B/E/S (Price Target, EPS, etc.) and Recommendation file to create the full time series of recommendations (initiations, reiterations, and revisions) made by each analyst for each firm for 14 years from 1999 to 2012. By adopting a modified version of "filling in the holes" method, we find that recommendation reiterations are prevalent, consisting of about 80% of recommendations for our 14-year sample period. Second, market response to recommendation reiterations increases monotonically from Reiteration: Strong Sell to Reiteration: Strong Buy. Third, reiterations coupled with contemporary changes in price targets and/or earning forecasts bring substantial absolute abnormal stock returns to investors. Lastly, when we replicate what Loh and Stulz (2011), we find that the number of reiterations which are influential is more than twice that of recommendation revisions that are influential.