CHANGES IN ANALYSTS’ RECOMMENDATIONS: WHICH SIGNAL LEADS THE MARKET?

Abstract

Based on the U.S. market, this study analyses changes in analysts’ recommendations on stock price with respect to two different benchmarks, namely, analysts’ previous recommendations and market consensus recommendations. This allows us to make a comparison between these two benchmarks and the level of recommendation to deduce the stronger signal. We use cumulative abnormal returns to examine the stock price impact of these factors. This study also controls for other factors that affect cumulative abnormal returns and provides robustness checks to ensure the reliability and generality of the results. Our findings indicate that upgrades (downgrades) relative to both benchmarks result in a positive (negative) stock price reaction after controlling for the level of recommendation. In particular, we find that the larger the upgrade or downgrade relative to both benchmarks, the greater the absolute cumulative abnormal returns obtained. Based on our analysis, changes in analysts’ recommendations relative to analysts’ previous recommendations appear to be the signal that leads the market, resulting in the largest price impact. In addition, we look at the impact of Regulation Fair Disclosure on analysts’ recommendations. We find a distinct increase in the proportion of ‘sell’ and ‘underperform’ recommendations post-Regulation Fair Disclosure. This allows us to overcome the limitations that previous studies face in terms of the low proportion of negative analysts’ recommendations. Overall, there is a decrease in stock price reaction for upgrades and downgrades relative to both benchmarks post-Regulation Fair Disclosure, implying that there is a reduction in the informativeness of analysts’ recommendations. Lastly, we examine the impact of analysts’ reputation on stock price reaction and conclude that upgrades and downgrades relative to both benchmarks have a larger price impact if they are issued by analysts with higher reputation.