When Do Sell‐side Analyst Reports Really Matter? Shareholder Protection, Institutional Investors and the Informativeness of Equity Research

AuthorAndreas Walter,Alexander Kerl,Daniel Arand
Date01 June 2015
DOIhttp://doi.org/10.1111/j.1468-036X.2013.12028.x
Published date01 June 2015
When Do Sellside Analyst Reports
Really Matter? Shareholder Protection,
Institutional Investors and the
Informativeness of Equity Research
Daniel Arand, Alexander Kerl and Andreas Walter
Department of Financial Services, University of Giessen, Licher Str. 74, 35394, Giessen, Germany
E-mail: Alexander.Kerl@wirtschaft.uni-giessen.de
Abstract
We examine whether the informativeness of sellside analyst reports depends on the
strength of the regulatory environment of a country and the regulatory background
of the institutional investors of a company. Based on both measures that we use to
proxy the informativeness of analyst research (i.e., shortterm market reaction and
forecast errors with respect to corporate earnings), our results show that the
information value of research increases as the level of investor protection
increases. This result is robust to different specif‌ications of investor protection. We
further demonstrate that analyst forecasts are more (less) valuable when the
majority of institutional investors are from strong (weak) investor protection
countries.
Keywords: shareholder protection, institutional investors, analyst reports, regulation
JEL classification: G14, G15, G18, G24, G32
1. Introduction
This paper addresses the question to what extent the informativeness of sellside analyst
research depends on the prevailing regulatory environment. On the one hand, the previous
literature considers the information environment, such as the regulatory and institutional
background of a company, and the informativeness of analyst research as substitutes (see,
e.g., Subramanyam, 1996). That is, analysts are more relevant to the stock market when
We thank an anonymous referee for valuable comments and suggestions. Furthermore, we
thank seminar participants at the 2012 Cologne financial market colloquium, the 2012
European Financial Management Association (EFMA) annual meeting in Barcelona, and
the 2013 Midwest Finance Association (MFA) annual meeting in Chicago, for helpful
comments. Correspondence: Alexander Kerl.
European Financial Management, Vol. 21, No. 3, 2015, 524555
doi: 10.1111/j.1468-036X.2013.12028.x
© 2013 John Wiley & Sons Ltd
other sources of information are scant. Loh and Stulz (2011), for example, f‌ind that
analystsrecommendations are more likely to be inf‌luential on stock prices in the case of
small companies with only low analyst following. Similarly, Lang et al. (2004) report a
positive valuation effect of analyst coverage in the case of poor internal and weak country
level external governance.
On the other hand, other studies suggest that the general information environment of a
company and the informativeness of analyst research are complements. Francis et al.
(2002), for example, f‌ind a positive relation between abnormal returns and the information
contained in both earnings information and analyst reports. The authors do not f‌ind that
the informativeness of earnings announcements is reduced by the simultaneous
publication of analyst reports. In line with this result, Frankel et al. (2006) explicitly
state that the information value of analyst research and f‌inancial statements are
complements and that analyst report informativeness increases with institutional
ownership. This could be due to the fact that better shareholder protection leads to a
higher quality of f‌inancial reporting and corporate disclosure that ultimately translates into
better inputs for analyst research, and, hence, more valuable forecasts.
Based on this evidence, we consider the relationship between analyst research and the
regulatory environment an empirical issue that has not yet been resolved. We add to the
literature that has primarily used the legal environment and ownership structure of a
company to explain analystsincentives to produce analyst research and to cover certain
stocks.
1
Related to this topic, the previous research has found plenty of evidence in regard
to the regulatory and institutional environments positive inf‌luence on the quality of
f‌inancial reporting (see, e.g., La Porta et al., 2000; Ball et al., 2000). Leuz et al. (2003)
reveal that earnings management decreases in investor protection. DeFond et al. (2007)
further show that annual earnings announcements are more informative in countries in
which insider trading laws are better enforced. Similarly, Haw et al. (2012) f‌ind that in
countries with strong investor protection, greater f‌inancial disclosure and higherquality
earnings are associated with more informative stock prices about future earnings. With
respect to the shareholder structure of a company, Yeo et al. (2002) and Velury and
Jenkins (2006) demonstrate that the quality of reported earnings increases with
institutional ownership. This f‌inding is consistent with large external stockholders
assuming a monitoring role in corporations (see, e.g., Shleifer and Vishny, 1986; Chen
et al., 2007).
Following this evidence, our study contributes to the existing literature by analysing
whether the regulatory environment inf‌luences the informativeness of analyst research
because analysts directly depend on the quality of information available to them as inputs.
Hence, we evaluate whether the informativeness of analystsresearch is affected by (i) the
overall level of investor protection within a country and (ii) the regulatory background of
the institutional investors of a company. To measure the informativeness of forecasts, we
use two different approaches. First, we follow Frankel et al. (2006) by focusing on the
shortterm market reaction in response to the publication of an analyst report. Under the
1
Bushman et al. (2005), for example, f‌ind that the strength of the legal environment is
positively associated with the number of analysts issuing research on a company. Similarly,
Bhushan (1989) argues that analyst following increases in institutional ownership. This
f‌inding could be related to the fact that institutional investors are the main consumers of
analyst research.
© 2013 John Wiley & Sons Ltd
When Do Sellside Analyst Reports Really Matter? 525
assumption of eff‌icient capital markets in which any new information instantaneously
inf‌luences stock prices, the market reactions following the revision of analystsforecasts
serve as a valid proxy for the information value that market participants attribute to new
information. Second, we also compute reportspecif‌ic earnings forecast errors. By
comparing, for example, the actual reported earnings with the previously issued earnings
forecast, it is possible to identify which forecasts were more accurate and therefore
contained more information value.
Before describing our results, we would like to comment on the measures that we use to
identify the level of investor protection. Because different shareholder protection and
regulatory enforcement measures have been suggested within the previous literature (e.g.,
La Porta et al., 1998; Djankov et al., 2008; Jackson and Roe, 2009), we deploy a set of
conceptually different approaches in this context. These measures cover formal indicators
of the strength of the applicable shareholder rights law as well as enforcement proxies that
estimate the degree to which individuals and institutions can rely on norms and
regulations being put into effect and the intensity with which wrongdoing is being
prosecuted.
With respect to the f‌irst measure of forecast informativeness, namely, the shortterm
market reaction, our results reveal that the value of analyst reports depends signif‌icantly
on the countryspecif‌ic level of investor protection. For analyststarget price and earnings
forecast revisions
2
,wef‌ind a material increasein information value as the level of investor
protection increases. However, our results also show that recommendation upgrades are
hardly considered valuable within strong investor protection countries, whereas this is the
case in weak investor protection environments. One possible explanation for this f‌inding
is that strong investor protection markets such as the USA are characterised by more
sophisticated market participants who properly discount the value of potentially biased
recommendations. All our results are robust to the different specif‌ications of investor
protection that we apply.
We further ref‌ine our analyses and f‌ind that the information value of analystsforecasts
also depends on the investorspecif‌ic regulatory background. In particular, our results
suggest that the informativeness of analystsforecasts increases (decreases) in line with
the percentage of institutional investors from strong (weak) investor protection countries.
For example, in the subset of companies located in strong investor protection
environments such as the USA, those companies with a high percentage of foreign
institutional ownership (and, hence, an increased likelihood of institutional shareholders
being located in less regulated countries) presumably are characterised by worse
governance and a lower quality of f‌inancial reporting. This scenario consequently leads to
analyst forecasts that are of reduced information value. Analogously, we f‌ind that
companies located in weak investor protection environments benef‌it from a high
percentage of foreign institutional ownership (and, hence, an increased likelihood of
institutional shareholders being located in more regulated countries). This result could be
attributed to better governance, which positively affects a companys information
environment and ultimately results in analyst research of higher information value. Our
results therefore support the previous f‌indings of Aggarwal et al. (2011) who have shown
2
For the purpose of this paper, revisionsin terms of analystsstock recommendations, target
prices and earnings forecasts include both changes and reiterations of the prior forecast levels.
© 2013 John Wiley & Sons Ltd
526 Daniel Arand, Alexander Kerl and Andreas Walter

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT