Do Analyst Stock Recommendations Piggyback on Recent Corporate News? An Analysis of Regular‐Hour and After‐Hours Revisions

• Author: MIN SHEN,EDWARD XUEJUN LI,JOANNA SHUANG WU,K. RAMESH
• DOI: http://doi.org/10.1111/1475-679X.12083
• Date: 01 September 2015
• Published date: 01 September 2015

DOI: 10.1111/1475-679X.12083

Journal of Accounting Research

Vol. 53 No. 4 September 2015

Printed in U.S.A.

Do Analyst Stock Recommendations

Piggyback on Recent Corporate

News? An Analysis of Regular-Hour

and After-Hours Revisions

EDWARD XUEJUN LI,

∗K. RAMESH,

†MIN SHEN,

∗

AND JOANNA SHUANG WU

‡

Received 25 May 2014; accepted 13 March 2015

ABSTRACT

Analysts often update their recommendations following corporate news.

Questions have been raised regarding analysts’ ability to generate new in-

formation beyond recent corporate events. Employing a comprehensive

database on corporate news, we show that only a small minority, or 27.9%,

of all recommendation revisions directionally confirm the information in

the preceding corporate events and even these “confirming revisions” facil-

itate the information discovery of corporate events and thus cannot simply

be dismissed as “piggybacking.” Our analysis further shows that analysts not

only facilitate price discovery to corporate news through issuing trending

revisions but also help reverse prevailing market sentiments following cor-

porate news by issuing contrarian revisions. Our study is the first to investi-

gate short-window intraday market reactions to revisions issued after hours,

∗Baruch College; †Rice University; ‡University of Rochester.

Accepted by Philip Berger. We gratefully acknowledge helpful comments from an anony-

mous reviewer,Zhaoyang Gu, Shane Heitzman, Jaewoo Kim, Jerr y Zimmerman, and workshop

participants from TempleUniversity. We thank Jesse Hoeffner and Stephane Rochon of Credit

Suisse and Steven Poser, Vice President in the Strategic Analysis and Market Data Group at

NYSE Euronext, for helpful discussions. Financial support is provided by the Zicklin School of

Business at Baruch College, the Jones Graduate School of Business at Rice University, and the

Simon Business School at the University of Rochester. An online appendix to this paper can

be downloaded at http://research.chicagobooth.edu/arc/journal/onlineappendices.aspx.

821

Copyright C, University of Chicago on behalf of the Accounting Research Center,2015

822 E.X.LI,K.RAMESH,M.SHEN,AND J.S.WU

which account for 70% of all recommendation revisions in our sample pe-

riod. Analysts’ incentives to issue revisions after hours appear to reflect de-

mands from large institutional clients, who dominate after-hours trading.

More importantly, we show that the after-hours revisions are associated with

significantly greater price reactions and different price reaction patterns than

revisions issued during regular trading hours. Collectively, our evidence indi-

cates that analysts are a significant source of new information beyond recent

corporate news and they also help shape the market’s assessment of corporate

disclosures.

JEL codes: G11; G12; G14; G24; M41

Keywords: stock recommendation; after-hours revisions; piggybacking;

security analysts

1. Introduction

Analysts often update their recommendations following corporate news.

For example, Ivkovi´

c and Jegadeesh [2004] show that the frequency of

recommendation revisions increases sharply following earnings announce-

ments. A natural question arises about the incremental information

content of recommendation revisions beyond the preceding corporate

news. Even though many prior studies, such as Womack [1996], Francis

and Soffer [1997], and Asquith, Mikhail, and Au [2005], show that rec-

ommendation revisions generate significant price reactions, their reliance

on daily instead of intraday stock returns makes it difficult to disentangle

the price effects from recommendation revisions versus price reactions to

prior corporate events. More recent work by Altınkılıc¸ and Hansen [2009]

suggests that the vast majority of recommendation revisions come closely

after corporate news. Their intraday price reaction analysis documents

disproportionately large price reactions in the preannouncement window

of the revisions, which these authors attribute to analysts piggybacking on

prior corporate news.

The goal of our study is to provide a better understanding of the in-

teractions between recommendation revisions and corporate news and to

speak directly to the piggybacking hypothesis. Our study is uniquely fitted

for this purpose for two reasons. First, we use a large and comprehensive

database from Thomson Reuters on corporate news between 2003 and

2010. This database not only allows us to directly assess the incidence of

analyst recommendation revisions that closely follow corporate news but

also makes it feasible for us to measure the price reactions to the corporate

events and link them to the directions of the revisions. An analysis of the

price reactions to the corporate events themselves is important for making

inferences regarding analyst piggybacking but such an analysis is missing

from prior literature. Second, we employ intraday returns data to study

both regular-hour revisions as well as after-hours revisions. After-hours

revisions are excluded from prior literature’s intraday price reaction

DO ANALYST STOCK RECOMMENDATIONS PIGGYBACK 823

tests although they account for an increasing proportion of all revisions

and consist of 70% of all revisions during our sample period. Inferences

regarding recommendation revisions cannot be complete without a careful

analysis of the after-hours revisions.

Investigating how recommendations interact with prior corporate news

is important for understanding the roles financial analysts play in the

capital markets—whether they generate new information with their stock

recommendations or mainly serve other roles, such as marketing, for

their employers. Brokerage firms spend billions of dollars each year to

produce sell-side equity research with the goals of generating trading

commissions and facilitating corporate advisory services (e.g., Lin and

McNichols [1998], Irvine [2000]).1A cynical view of analyst research is that

it is primarily a marketing tool for the brokerage houses’ other services.

Academic research has documented optimistic biases in analyst research

and calls into question its objectivity and informativeness (e.g., Lin and

McNichols [1998], Bradshaw [2004]). Some researchers argue that analyst

recommendations mostly “regurgitate” recent corporate news and the

price reactions observed around recommendation revisions are in fact

attributable to the corporate news immediately preceding the revisions

themselves (e.g., Altınkılıc¸ and Hansen [2009]).

On the other hand, there are reasons to believe that analysts generate

new information through their stock recommendations. The significance

of stock recommendations to investors and to the brokerage houses that

produce them is illustrated by a 2006 lawsuit brought by several prominent

brokerage firms (Barclays Capital, formerly Lehman Brothers, Morgan

Stanley, and Merrill Lynch) against TheFlyOnTheWall.com, a subscription-

based Internet news gathering service (“Fly”). The brokerage houses allege,

among other things, “hot news misappropriation,” which involves unautho-

rized distribution by Fly of the brokerage firms’ newly issued stock recom-

mendations to parties that are not the firms’ clients. The court opinion

issued in 2010 describes the great lengths the brokerage firms go to, includ-

ing taking legal actions against Fly, in order to prevent the immediate dis-

tribution of their newly issued stock recommendations to nonclients. The

brokerage firms argue that Fly’s actions erode the investment value of the

stock recommendations to the brokerage firms’ clients, who pay for the re-

search through soft dollar trading commissions.2The fact that investors are

willing to pay for the stock recommendations either directly (e.g., through

1See, for example, “Analyse this: The economics of equity research.” The Economist,

September 21, 2013.

2The U.S. District Court for the Southern District of New York ruled in favor of the bro-

kerage firms in 2010, requiring Fly to delay its distribution of the brokerage firms’ stock rec-

ommendations (Barclays Capital Inc., et al. v. TheFlyOnTheWall.com,Inc. 06Civ. 4908, March

18, 2010). However, the District Court’s decision was reversed in 2011 by the Second Circuit

Court (Barclays Capital Inc., et al. v. TheFlyOnTheWall.com, Inc. 2nd Cir., June 20, 2011).

Specifically, the Second Circuit Court concluded that, while analyst firms “make news” by issu-

ing recommendations, they do not have the right “to control who breaks that news and how.”