When Analysts Talk, Do Institutional Investors Listen? Evidence from Target Price Changes

Published date01 May 2016
Date01 May 2016
The Financial Review 51 (2016) 191–223
When Analysts Talk, Do Institutional
Investors Listen? Evidence from Target
Price Changes
Shannon Lin
Dalhousie University
Hongping Tan
York University
Zenan Zhang
Jiangnan University
We find that institutions trade in the same direction as target price changes based on
6,415 U.S. firms from 1999 to 2011, even after controlling changes in stock recommendations
and earnings forecasts. The impact of target price changes on institutional trading is more
pronounced for small firms, firms followed by few analysts, and illiquid firms, and is mainly
limited to transient institutions. We do not find any outperformance for institutions to follow
analysts’ target price forecasts, suggesting that institutions could find it easier to justify their
investment decisions by following analyst forecasts, although such trading does not result in
Corresponding author: Schulich School of Business, YorkUniversity, 4700 Keele Street, Toronto, M3J
1P3, Canada; Phone: (416) 736-2100, ext 30099; Fax: (416) 736-5687; E-mail: htan@schulich.yorku.ca.
The authors gratefully acknowledge helpful comments from an anonymous referee and the editor Srini
Krishnamurthy, as well as from conference and workshop participants at the Financial Management
Association 2011 Asian Conference, Northern Finance Association 2011 annual meeting, Financial Man-
agement Association 2011 annual meeting, Eastern Finance Association 2012 annual meeting, Nanyang
Business School, Wuhan University, and Zhongnan University of Economics and Law. We thank June
Woo Park and Changqiu Yu for excellent research assistance, and the Social Sciences and Humanities
Research Council of Canada for financial support. All errors are our own.
C2016 The Eastern Finance Association 191
192 S. Lin et al./The Financial Review 51 (2016) 191–223
Keywords: financial analyst, institutional trading, target price, recommendation, usefulness,
JEL Classifications: G11, G14, G29
1. Introduction
This paper examines the relationship between analyst research content and
institutional trading based on a large sample of analyst target price forecasts for 6,415
U.S. firms during 1999–2011. We investigate whether institutional investors trade on
the information contained in target prices, and identify firm and investor traits that
moderate the impact of target prices on institutional trading. Wealso examine whether
trading on target price information would be beneficial to institutional investors.
Target prices indicate the value assessment of underlying stocks by financial
analysts. They are typically included alongside earnings forecasts and stock recom-
mendations in analyst research reports but have largely been overlooked in the ana-
lyst literature until recently. An emerging literature investigates the determinants and
investment value of target price and its relation to earnings forecast and stock recom-
mendation, however,the claim in Brav and Lehavy (2003, p. 1933) that “their [target
prices’] role in conveying information to market participants and their contributionto
the formation of equity prices have remained largely unexplored” is still largely true
today (see, e.g., Bradshaw, 2002; Brav and Lehavy, 2003; Asquith, Mikhail and Au,
2005; Huang, Mian and Sankaraguruswamy, 2009; Gleason, Johnson and Li, 2013;
Bradley, Clarke, Lee and Ornthanalai, 2014).
The usefulness of analyst research in general, and that of target price in particular,
continues to be a widely debated topic among academics, investors, and regulators.
Despite a large literature that shows the informativeness of various components
of analyst research, there is concern over the objectivity and investment value of
analyst research given the conflicts of interest surrounding the securities research
industry. Essentially, analysts have been accused of biasing their research outputs to
attract investment banking business, to secure management access, and to generate
brokerage commissions (for a review on analyst forecast literature, see Ramnath,
Rock and Shane, 2008).
We examine the usefulness of target prices to presumably one of the most so-
phisticated investors and players in the stock market: institutional investors. A few
papers attribute institutional outperformance to the use of stock recommendations
by sell-side analysts (see, e.g., Chen and Cheng, 2006; Green, 2006; Oppenheimer
and Sun, 2009), leaving us to question whether analyst target prices also serve a
similar function. A casual reading of analyst reports reveals cases in which analysts
reiterate their stock recommendations but change their target price forecasts dramat-
ically, and instances in which they revise their stock recommendations but maintain
their previously issued target price forecasts. Since target prices can be implicitly
S. Lin et al./The Financial Review 51 (2016) 191–223 193
interpreted as analysts’ expectation of stock returns over the forecast horizon, they
should contain additional information beyond that conveyed by stock recommen-
dations. Earlier work by Brav and Lehavy (2003) demonstrates significant market
reaction to analysts’ target price revisions, even after controlling for contempora-
neously issued stock recommendation and earnings forecast revisions. Since both
Huang, Mian and Sankaraguruswamy (2009) and Da and Schaumburg (2011) offer
evidence that target price changes predict returns, we buildon these findings to further
investigate whether institutional investorsuse analyst target prices in their investment
decisions and how institutional investors respond to the information contained in
target prices in the presence of stock recommendations.
We find a positive relationship between institutional trading and target price
changes, consistent with the idea that institutions trade on target price changes.
Furthermore, the explanatory power of target price changes goes beyond that of
changes in recommendations and earnings forecasts, even after controlling for a host
of institutional trading determinants. Further analysis suggests that target prices and
stock recommendations might be capturing different sets of analysts’ information
that does not necessarily overlap. These results are robust to different measures of
target price changes and institutional trading. We also show that the positive relation
between target price change and institutional trading is more pronounced for small
firms, firms followed by feweranalysts, with lower liquidity, and with lower price-to-
earnings (P/E) ratio, and is limited to transient investors. Despite the implementation
of regulatory changes in the early 2000s targeting the conflicts of interest in the
securities research industry, we do not find institutional trading more sensitive to
target price changes in recent years. Finally, we do not find any outperformance for
institutions to follow analysts’ target price advice. Since institutions are governed by
the “Prudent-man rule,” they could find it easier to justify their investment decisions
by following analyst forecasts to trade, despite the fact that such trading does not
result in outperformance.
The rest of the paper proceeds as follows: Section 2 discusses the relevant
literature leading up to our hypotheses. Section 3 describes our sample and research
method. Section 4 illustrates empirical results. Section 5 is a returns analysis of
portfolios based on target price changes. Finally, section 6 concludes.
2. Literature review and hypotheses
Of the three major components of analyst research outputs (earnings forecasts,
stock recommendations, and target prices), much of the previous literature is limited
to the first two, focusing either on the cross-sectional differences and determinants
of performance among analysts, or on the market response to the issuance of these
forecasts.1A small but growing literature examines the determinants and investment
1See, for example, Stickel (1995), Barber, Lehavy, McNichols and Truman (2001), Bae, Stulz and Tan
(2008), Bradley, Chan, Kim and Singh (2008), Loh and Stulz (2011), and Bradley, Liu and Pantzalis

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