The Value of Analysts. Brad M. Barber Graduate School of Management UC Davis

Transcription

1 The Value of Analysts Brad M. Barber Graduate School of Management UC Davis

2 The Value of Analysts Do security analysts provide valuable information to investors? Who and why? Do conflicts of interest affect analysts? How has regulatory reform affected analysts?

3 The Role of Analysts Provide Research and Recommendations Buy-Side Analysts Mutual Funds Pension Funds Hedge Funds Sell-Side Analysts Brokerage Firm Issue BUY HOLD SELL recommendations

4 The Value of Sell-Side Recommendations Invest in a portfolio that follows the recommendations of analysts. 1. All BUYs Invest $1 in all BUY Recommendations SELL when recommendation changes or in 1 year 2. Upgrades to BUY 3. Upgrades to BUY, 1-month holding period SELL when recommendation changes or in 1 month

5 BUY HOLD SELL

6 Upgrade to BUY Downgrade to HOLD Downgrade to HOLD Holding Period: Until Recommendation Change or One Year

7 Upgrade to BUY Downgrade to HOLD Downgrade to HOLD Holding Period: Until Recommendation Change or One Month

8 Annual Return Spread BUY SELL

9 Conclusions Analysts recommendations convey value Most of the information is impounded within days of the recommendation Strategies based on recommendations will lose money High Turnover Transaction Costs

10 Influential Analysts Loh and Stulz, Review of Financial Studies, 2010 Nov 1, 2007: Meredith Whitney (CIBC) downgraded Citigroup saying that it needs to raise capital or cut its dividend to cope with the credit crisis. CITI dropped 6.9%, the CEO quit 2 days later, and the analyst apparently received death threats. Sep 1, 2009, Todd Bault (Bernstein) downgraded AIG and warned that investors are ignoring the fact that AIG s shares could be worth zero. AIG fell 20%.

11 Influential Analysts Loh and Stulz, Review of Financial Studies, 2010

12 Influential Analysts Loh and Stulz, Review of Financial Studies, 2010 Only 1 in 4 Analysts issue influential recommendations Which Analysts are influential? Institutional Investor All-Star Analysts Bold earnings forecasts Which Stocks are affected? Small Growth Hard-to-value stocks

13 School Ties Cohen, Frazzini, Malloy, Journal of Finance, 2010 Analyst Jones recommends HOLD for XYZ Corp. Jones maintains his HOLD and later drops coverage of XYZ Consensus recommendation is HOLD Analyst Smith upgrades XYZ stock to BUY in January XYZ announces earnings better than expected ABC corp. announces acquisition of XYZ in September Why did Smith issue correct recommendation? Better analysis? Better information?

14 Total Return School Ties Example Cohen, Frazzini, Malloy 2010 Merger completed 1.8 CFM announces its intention to acquire XYZ Earnings announcement Rumors of a possible acquisition XYZ Upgraded to BUY 0.8 Feb-93 Mar-93 Apr-93 May-93 Jun-93 Jul-93 Aug-93 Sep-93 Oct-93 Nov-93 Dec-93 XYZ Corp. DGTW benchmark portoflio Sell Side School Ties Lauren Cohen, Andrea Frazzini, and Christopher Malloy

15 CAR Event-Time Returns, This figures shows event time cumulative abnormal returns. We classify a stock as having educational ties to the analyst if he/she attended the same institution of a senior officer or a board member. BUY (SELL) portfolio consists of all stocks upgraded (downgraded) with respect to the previous recommendation 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% trading day t+k % -4.0% BUY, no shared educational background BUY, analyst connected to senior management or board of directors SELL, no shared educational background SELL, analyst connected to senior management or board of directors Sell Side School Ties Lauren Cohen, Andrea Frazzini, and Christopher Malloy

16 Regulation Fair Disclosure (Reg FD) SEC concerned about Selective Disclosure (1999) In many reported incidents, companies selectively disclosed important information such as upcoming earnings figures in conference calls or meetings that are open only to selected securities analysts and/or institutional investors, and which exclude members of the public and the media. Regulation FD adopted in August 2000 *W]hen an issuer discloses material nonpublic information to certain individuals or entities generally, securities market professionals, such as stock analysts, or holders of the issuer's securities who may well trade on the basis of the information the issuer must make public disclosure of that information. In this way, the new rule aims to promote the full and fair disclosure.

17 CAR Event-Time Returns, pre REG-FD This figures shows event time cumulative abnormal returns. We classify a stock as having educational ties to the analyst if he/she attended the same institution of a senior officer or a board member. BUY (SELL) portfolio consists of all stocks upgraded (downgraded) with respect to the previous recommendation 20.0% 15.0% 10.0% 5.0% 0.0% trading 118day t+k % -10.0% BUY, no shared educational background BUY, analyst connected to senior management or board of directors SELL, no shared educational background SELL, analyst connected to senior management or board of directors Sell Side School Ties Lauren Cohen, Andrea Frazzini, and Christopher Malloy

18 CAR Event-Time Returns, post REG-FD This figures shows event time cumulative abnormal returns. We classify a stock as having educational ties to the analyst if he/she attended the same institution of a senior officer or a board member. BUY (SELL) portfolio consists of all stocks upgraded (downgraded) with respect to the previous recommendation 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% % -2.0% trading day t+k -3.0% -4.0% -5.0% BUY, no shared educational background BUY, analyst linked to senior management or board of directors SELL, no shared educational background SELL, analyst linked to senior management or board of directors Sell Side School Ties Lauren Cohen, Andrea Frazzini, and Christopher Malloy

19 The Analyst Scandals Several corporate scandals for which analysts maintained Buy up until the scandals broke. Enron Healthsouth Worldcom A bouyant stock market with many internet startups Led to concerns and increased scrutiny by Congress and SEC, regarding potential analyst conflicts of interest and their role in the rise and fall of stock market.

20 The Blodget s PUBLIC Blodget publishes buy rating on June 3 We do not see much more downside to the shares July 20 PRIVATE Excite@Home is such a piece of c**p Blodget June 3 Lifeminders PUBLIC Blodget publishes buy rating on Dec 4 We think Lifeminders presents an attractive investment, Dec. 21 PRIVATE I can t believe what a POS *piece of s**t+ that thing is Dec. 4

21 Partitioning the securities firms 1. Sanctioned banks: the big ten investment banks (IB). 2. Lead underwriters: non-sanctioned IB that were lead/jointlead managers of at least one equity offering during the period. 3. Syndicate members: IB that were syndicate members of one or more equity offering during the sample period, but were never lead/joint-lead underwriter. 4. Independent research firms: no investment banking activities.

22 Buy Recommendation Portfolios: Investment Banks v. Independent Research Investment Banks Independent Firms -15 FEB-96 to JUN-03 FEB-96 to MAR-00 MAR-00 to JUN-03

23 Buy Recommendation Portfolios Equity Issuing Firms (IPO/SEO): Investment Banks v. Independent Research Investment Banks Independent Firms -15 FEB-96 to JUN-03 FEB-96 to MAR-00 MAR-00 to JUN-03

24 Buy Recommendation Portfolios Non-Issuing Firms: Investment Banks v. Independent Research Investment Banks Independent Firms -15 FEB-96 to JUN-03 FEB-96 to MAR-00 MAR-00 to JUN-03

25 In the aftermath Congressional hearings (June 2001) Analyzing the Analysts: Are Investors Getting Unbiased Research from Wall Street? The $1.4 billion Spitzer-led global research settlement on analysts conflicts of interest (Dec. 2002). NASD Rule 2711 (Research Analysts and Research Reports), and NYSE modification to Rule 472 (Communications with the Public).

26 Provisions of NASD Rule 2711 and modification of NYSE Rule 472 Restrictions on relationship between investment banking and research department. Restrictions on review of research report by subject company. Prohibition of certain forms of research analyst compensation. Prohibition of promise of favorable research. Imposition of quiet periods. Restrictions on personal trading by research analysts. NASD Rule 2711 (h)(5): Disclosure Requirements A member must disclose in each research report the percentage of all securities rated by the member to which the member assigns a "buy," "hold," or "sell" rating. NASD members must implement the provisions of Rule 2711(h)(5) no later than September 9, 2002.

27 Distribution of Recommendations

28 Average Rating 5 STRONG BUY, 4 BUY 1 STRONG SELL

29 Percentage SELL/STRONG SELL

30 Regulation affects Analysts

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32 Conclusions Analysts provide valuation information to financial markets Few influential analysts Some with privileged access to information Regulation has clear affects on analyst behavior Regulation FD appears to reduce the information conveyed by analysts Exchange rules increase the willingness of brokers to issue SELL recommendations BEWARE Unintended Consequences of Regulation One must think beyond the first order effects of proposed regulation Did restrictions on analysts create demand for Expert- Networks?