1. 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

2. “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).

3. 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.

4. 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.

5. 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)

6. 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

7. 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.

8. Sample IPOs of industrial firms issued in 1986-2000.
A total of 4,082 observations.
A total of 3,614 (89.0%) firms are covered in I/B/E/S.

9. Model of Initial Analyst Following

10. Post-Initial-Coverage Annualized Buy-and-Hold Returns

11. Fama-French and Momentum Adjusted Returns

12. Fama-MacBeth Panel Regression

13. Post-Initial-Coverage Operating Performance

14. 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.