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
• 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).
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.
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.
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)
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
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.
Sample
• IPOs of industrial firms issued in 19862000.
• A total of 4,082 observations.
• A total of 3,614 (89.0%) firms are covered
in I/B/E/S.
Model of Initial Analyst Following
Post-Initial-Coverage Annualized Buy-and-Hold Returns
Fama-French and Momentum Adjusted Returns
Fama-MacBeth Panel Regression
Post-Initial-Coverage Operating Performance
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.