eThesis - Kauppakorkeakoulun sähköiset gradut

Stock market research industry has changed quite dramatically during the recent decade. Adverse regulatory changes and diminishing trading commissions have led to a decline in incentives to conduct analyst research on public companies. Many companies have lost all of their analyst coverage and some of the prominent market participants, including Securities and Exchange commission (SEC), have begun to worry about the amount of quality research disappearing from capital markets.

The purpose of this study is to examine how analyst research affects the information environment of capital markets and more precisely what is the impact of analyst coverage initiations on information asymmetry and firm value. Sample consists of 517 publicly listed U.S. companies that didn't have any analyst coverage for at least six months before they gained analyst coverage. I measure the impact on information asymmetry by comparing pre- and post-initiation trading volumes and bid-ask spreads to see whether coverage initiations cause a significant change in these stock characteristics. I also measure the impact of coverage initiation on firm value by calculating abnormal returns around [-1,+1] days and [-2,+2] days around coverage initiations to see whether the change in information environment results in changes in company market value.

I find that analyst coverage initiations are important information events. Coverage initiations enhance the information environment of a company's stock by increasing trading volumes and decreasing bid-ask spreads. I also find that stock market reacts positively to analyst coverage initiations by producing an average abnormal return of 3,27 % around [-1,+1] days around coverage initiation. By expanding the window to [-2,+2] days around coverage, average initiation abnormal return increases to 4,33 %.

Positive gains in trading volumes, bid-ask spreads and abnormal returns seem to be driven by coverage initiations with positive analyst recommendations. There is also a clear relationship between analyst recommendation and the change in trading volumes and company market value. Positive recommendations result in significant positive abnormal returns and negative recommendations, vice versa, result in significant negative abnormal returns.

The results of this study suggest that capital market regulators and public companies should pay more attention to the extent and quality of analyst coverage, because there are significant benefits to be attained from increasing analyst coverage in the form of decreasing information asymmetry and more efficient price discovery process of company's shares.