Stock price informativeness and analyst coverage
| DOI | http://doi.org/10.1002/cjas.1253 |
| Author | Guy Charest,Jean‐Claude Cosset,Bouchra M'Zali,Ahmed Marhfor |
| Date | 01 September 2013 |
| Published date | 01 September 2013 |
Stock price informativeness and
analyst coverage
Ahmed Marhfor*
University of Quebec in Abitibi-Témiscamingue
Bouchra M’Zali
ESG/UQÀM
Jean-Claude Cosset
HEC Montréal
Guy Charest
ESG/UQÀM
Abstract
We examine whether more analyst coverage translates into
more informative stock prices and apply this to both developed
and emerging markets. We measure price informativeness
using the association between current stock returns and future
earnings. We argue that more informative stock prices contain
more information about future earnings. Results indicate that
analysts’activities do not contribute to the impounding of future
earnings information into current stock prices, in accordance
with the view that analysts are outsiders who do not have full
access to firm-level information. We also find that analysts
specialize according to industry and that “industry expertise”
is limited to developed countries. Overall, our evidence is
consistent with the explanation that analysts focus on gathering
and mapping industry- and market-level information (macro-
economic information) into stock prices. Copyright © 2013
ASAC. Published by John Wiley & Sons, Ltd.
JEL Classifications: G14, G15, G24
Keywords: analyst coverage, stock price informativeness,
firm-specific information, earnings forecasts, future earnings
response coefficients
Résumé
Cet article vérifie si davantage de couverture par les
analystes débouche sur des cours d’action plus riches en
informations. Il applique cette vérification à la fois aux
marchés développés et aux marchés émergents. Le caractère
informatif des cours est mesuré à partir de l’association
entre les rendements d’action et bénéfices futurs de
l’entreprise. L’étude soutient que les cours d’action plus
informatifs contiennent plus d’informations sur les bénéfices
futurs de l’entreprise. D’après les résultats, les activités des
analystes ne contribuent pas à emmagasiner les informa-
tions sur les gains futurs dans les cours actuels des actions,
vu que les analystes sont des outsiders qui n’ont pas un
accès total aux informations de l’entreprise. Par ailleurs,
les analystes se spécialisent en fonction des industries et
cette «expertise en industrie» se limite aux pays développés.
En somme, les résultats corroborent l’explication suivant
laquelle les analystes se focalisent sur la collecte et
l’organisation des informations issues du marché et de
l’industrie (informations macroéconomiques).
Mots-clés : couverture par les analystes, caractère informatif
du cours des actions, informations propres à la firme, pré-
visions de gains, coefficients de réponse de gains futurs
In this paper, we investigate whether more analyst coverage
is associated with stock prices reflecting more information about
future earnings. The paper is motivated by the recent financial
crisis (2008) and multiple scandals (e.g., Libor manipulation
and JPMorgan trading loss) that shook investors’confidence in
financial markets and the potential useful role of security ana-
lysts. Financial analysts are said to impact capital markets by
providing firm-specific information, foremost including earnings
forecasts. Their activities are meant to reduce information
asymmetries between market participants, thereby helping to
keep stock prices in line with firm fundamentals. Such an infor-
mational role is deemed important given that innumerable small
investors lack both the time and the resources to fully appraise
firm stocks. On the other hand, the recent financial crisis showed
the inadequate dissemination of firm-specific information to
small investors. Hence, unresolved questions keep surfacing:
Do analysts act as providers of firm-specific information? Do
they focus on serving their own interests (generate investment-
banking business and trading commissions) at the expense of
other market participants?
Our contributionin addressing these questions is twofold.
First, we choose future earnings response coefficients as our
*Please address correspondence to: Ahmed Marhfor, University of Quebec
in Abitibi-Témiscamingue. Email: Ahmed.Marhfor@uqat.ca
Canadian Journal of Administrative Sciences
Revue canadienne des sciences de l’administration
30: 173–188 (2013)
Published online in Wiley Online Library (wileyonlinelibrary.com). DOI: 10.1002/CJAS.1253
Can J Adm Sci
30(3), 173–188 (2013)Copyright © 2013 ASAC. Published by John Wiley & Sons, Ltd. 173
proxy for stock price informativeness (Collins, Kothari,
Shanken, & Sloan,1994; Durnev, Morck, Yeung, & Zarowin,
2003; Gelb & Zarowin, 2002;Lundholm & Myers, 2002) and
examine its relationto analyst coverage. The purpose is to test
whether coverage by multiple analysts facilitates stock price
discovery. We argue that an important determinant of price
discovery is the re-evaluation of expectations about firms’
future earnings. Hence,we conjecture that, if security analysts
essentially accessa large amount of firm-specifici nformation,
their coverage should leave less information about future
earnings that can be privately discovered. Consequently,
stocks that are followed by a large number of analysts should
exhibit price convergence to firms’fundamentals (e.g., future
earnings). Despite its common-sense appeal, our approach
has yet to appear in the analyst-coverage literature. To our
knowledge, no other paper examines how the activities of
analysts affect the mix of earnings information reflected in
current stock prices. Two studies that are close in spirit to
our research are Piotroski and Roulstone (2004) and Chan
and Hameed (2006). Using stock price synchronicity as a
proxy for price informativeness, these same authors have
documented a positive relation between analyst coverage
and stock return synchronicity, indicating that the activities
of analysts generate market-wide information and decrease
the amount of firm-specific informationthat is impounded into
stock prices. These two studies build on the premise that the
portion of stock prices not attributable to market and industry
factors represents firm-specificinformation.
Following Roll (1988), we argue that such a portion
could reflect either private information or noise. The latter
results in part from the presence of uninformed investors
who trade based on second-hand news and rumours. In fact,
the potential presence of some noise-related volatility in
stock price movements should weaken the findings of
Piotroski and Roulstone and Chan and Hameed as this pre-
sents an alternative interpretation of their results that firms
covered by a large number of analysts tend to have less
noisy prices. This alternative explanation is consistent with
the fact that analysts play a positive role in capital markets,
which runs contrary to the conclusions of Piotroski and
Roulstone and Chan and Hameed. In our approach, we pro-
pose a measure that captures more precisely and directly an-
alysts’produced earnings information. We argue that
analysts can affect stock prices through earnings forecasts
and stock recommendations. However, some might argue
that our proxy of price informativeness may not capture
other value-relevant information such as stock recommenda-
tions.
1
We conjecture a strong relation between both pieces
of information since high (low) earnings targets should re-
sult in buy (sell) recommendations. In fact, if analysts issue
high future earnings estimates for a stock, they then recom-
mend buying the stock. If they expect low earnings estimates
in the future, they recommend selling the stock. Hence, our
proxy of price informativeness may also capture information
linked to stock recommendations. In addition, our empirical
tests—contrary to the findings of Piotroski and Roulstone and
Chan and Hameed—do not require that stock markets be
efficient
2
(semi-strong form) because we test relative
informativeness (information about future earnings and not
necessarily all public information). This is desirable because in
some countries (e.g., emerging countries), we could document
weak associations between price informativeness and analyst fol-
lowing due mainly to a less-efficient price-discovery process. In
the same line of reasoning, our approach also contrasts with the
results of prior studies (Chang, Khanna, & Palepu, 2000; Hope,
2003) in that we measure directly the relation between current
stock prices and future earnings instead of using indirect proxies
of price informativeness such as analysts’forecast error. As
suggested by Gelb and Zarowin (2002, p. 35), “more accurate
analysts’forecasts might be evidence of firms ‘managing’their
analyst relationships better (i.e., whisper numbers), rather than
evidence of more informative prices.”
Second, through a global investigation, we cover analysts’
activities in both developed and emerging markets. Few studies
have thus far focused on the potential cross-sectional
differences in the role played by analysts in different economic
and institutional environments. Obviously, in countries with
weak institutions and less stringent disclosure requirements,
financial analysts are at a disadvantage compared to insiders
regarding access to firm-specific information. Moreover, weak
property rights in these countries may discourage informed
arbitrage (Morck, Yeung, & Yu, 2000). Consequently, the
benefits of collecting private (firm-specific) information by
analysts should be poor because it is not optimal to trade on
such information. Following these arguments, we expect a
weaker link between our measure of price informativeness
and analyst coverage in countries with weak institutions.
Finally, to reinforce our conclusions regarding the relation
between analyst coverage and price informativeness, it is useful
to further investigate any potential differences in our empirical
results between a firm-by-firm approach and an industry-level
approach. The motivation behind this additional analysis is
the mounting evidence in the literature (Chan & Hameed,
2006; Piotroski & Roulstone, 2004) suggesting that analysts
do not specialize in the production of firm-specific information.
As a result, security analysts could direct their attention toward
gathering and disseminating industry-level information. In fact,
many studies (Clement, 1999; Jacob, Lys, & Neale, 1999;
Ramnath, 2002) document substantial industry specialization.
For instance, according to Piotroski and Roulstone (2004), the
net effect of analyst coverage improves the incorporation of
industry-level information into stock prices.
We document three main empirical results. First, we find
that analysts’forecasting activities do not improve the flow of
information on firms’fundamentals (e.g., future earnings) into
stock prices. In fact, our results suggest that stocks covered by
more analysts incorporate less firm-specific information linked
to fundamentals. This evidence is consistent with the results
reported by Piotroski and Roulstone (2004) and Chan and
Hameed (2006), who also found that stocks covered by more
STOCK PRICE INFORMATIVENESS AND ANALYST COVERAGE MARHFOR ET AL.
Can J Adm Sci
30(3), 173–188 (2013)Copyright © 2013 ASAC. Published by John Wiley & Sons, Ltd. 174
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