Analyst following, Institutional investors, Information costs

We examine the effect of underwriting relationships on analysts' earnings forecasts and recommendations. Lead and co-underwriter analysts' growth forecasts and recommendations are significantly more favorable than those made by unaffiliated analysts, although their earnings forecasts are not generally greater. Investors respond similarly to lead underwriter and unaffiliated `Strong buy' and `Buy' recommendations, but three-day returns to lead underwriter `Hold' recommendations are significantly more negative than those to unaffiliated `Hold' recommendations. The findings suggest investors expect lead analysts are more likely to recommend `Hold' when `Sell' is warranted. The post-announcement returns following affiliated and unaffiliated analysts' recommendations are not significantly different.

This paper provides evidence that firms signal their private information about future earnings by their choice of split factor. Split factors are increasing in earnings forecast errors, after controlling for differences in pre-split price and firm size. Furthermore, price changes at stock dividend and split announcements are significantly correlated with split factors, holding other factors constant, and with earnings forecast errors. These correlations suggest that management's choice of split factor signals private information about future earnings and that investors revise their beliefs about firm value accordingly. The analysis also suggests, however, that announcement returns are significantly correlated with split factors after controlling for earnings forecast errors. This suggests that earnings forecast errors measure management's private information about future earnings with error, that split factors signal other valuation-relevant attributes, or that a signaling explanation is incomplete.

This paper investigates whether the market rewards firms meeting current period earnings expectations, and whether any such reward reflects the implications of meeting expectations in the current period for future earnings or reflects a distinct market premium. We document that abnormal annual returns are significantly greater for firms meeting expectations, controlling for the information in the current year’s earnings. We then test whether firms meeting expectations experience higher returns simply because their expected future earnings are also higher. We find firms meeting expectations have significantly higher earnings forecasts and realized earnings than firms that do not. We find that controlling for these higher future earnings, firms meeting expectations in one or two years do not receive a greater valuation than their fundamentals would suggest. We find, however, that the market assigns a higher value to firms that meet expectations consistently, controlling for an estimate of the firm’s fundamental value.

This study examines whether investment banking ties influence the speed with which analysts convey unfavorable news. We hypothesize that affiliated analysts have incentives to respond promptly to good news but prefer not to issue bad news about client companies. Using duration models of the time between an equity issue and the first downgrade, we find affiliated analysts are slower to downgrade from Buy and Hold recommendations and significantly faster to upgrade from Hold recommendations, in both within-analyst and within-issuer tests. We also find affiliated analysts issue recommendations sooner and more frequently after an offering than unaffiliated analysts, and that unaffiliated analysts are more likely than affiliated analysts to drop coverage of sample firms. Our findings indicate that banking ties increase analysts' reluctance to reveal negative news, and that reform efforts must carefully consider the incentives of affiliated and unaffiliated analysts to initiate coverage and convey the results of their research.

Mary E. Barth, Maureen F. McNichols, Estimation and Market Valuation of Environmental Liabilities Relating to Superfund Sites, Journal of Accounting Research, Vol. 32, Studies on Accounting, Financial Disclosures, and the Law (1994), pp. 177-209