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Analyst’s Selective Coverage and Subsequent Performance of Newly Public Firms

Analyst’s Selective Coverage and Subsequent Performance of Newly Public Firms. Somnath Das Re-Jin Guo University of Illinois at Chicago Huai Zhang Hong Kong University 2004 NTU International Conference on Finance December, 2004. “Analysts” in IPO Market.

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Analyst’s Selective Coverage and Subsequent Performance of Newly Public Firms

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  1. Analyst’s Selective Coverage and Subsequent Performance of Newly Public Firms Somnath Das Re-Jin Guo University of Illinois at Chicago Huai Zhang Hong Kong University 2004 NTU International Conference on Finance December, 2004

  2. “Analysts” in IPO Market • Analysts provide over-optimistic forecasts (Rajan and Servaes, 1997). • Analysts have distorted incentives (Dechow, Hutton, and Sloan, 2000). • Analysts can generate “demand” for shares in the short-run (Aggarwal, Krigman, and Womack, 2002).

  3. Our Paper • (Sell-side) Analysts possess superior ability to predict the future performance of IPO firms. • Measure of analysts’ true expectation. • Analysts’ ex ante expectation is confirmed by a firm’s ex post performance.

  4. Analysts’ Selective Coverage • Variation in analyst coverage (Hong, Lim, and Stein, 2000). • Analysts’ reluctance to issue non-optimistic recommendations/forecasts. • Analysts’ reputation. • McNicholas and O’Brien (1997) • Analysts more likely to provide coverage for firms with favorable expectation. • No coverage when expectations are sufficiently low. • Truncated sample on analysts’ published opinion.

  5. The burgeoning IPO market makes it tough for analysts to follow every deal…. With so many deals coming through, at some point analysts have to pick and choose, and they are going to Choose companies with great long-term prospects. That’s how their firms make money. ---- Finegan,et al (1996)

  6. Measure of Analysts’ True Expectation unobservable Total number of analysts providing coverage =f (expectation of firm’s future performance, firm size, industry size, offering characteristics…..) Expectation of firm’s future performance ~ residual coverage

  7. Research Design • Residual coverage measures analysts’ (aggregate) true expectation of firm’s future performance. • Relate residual coverage to: • Post-coverage long-term return performance. • Post-coverage operating performance.

  8. Sample • IPOs of industrial firms issued in 1986-2000. • A total of 4,082 observations. • A total of 3,614 (89.0%) firms are covered in I/B/E/S.

  9. Model of Initial Analyst Following

  10. Post-Initial-Coverage Annualized Buy-and-Hold Returns

  11. Fama-French and Momentum Adjusted Returns

  12. Fama-MacBeth Panel Regression

  13. Post-Initial-Coverage Operating Performance

  14. Conclusion • Analysts have superior ability in predicting firm’s future performance. • Analysts are more likely to provide coverage on stocks about which their true expectations are favorable. • Analysis based on recommendation/forecast data may suffer from selection bias.

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