Are U.S. Analysts’ Recommendation Changes For Cross-Listed Stocks More Informative Than Local Analysts’?
University of Cambridge – Judge Business School
Antonio Carlo Francesco Della Bina
University of Bologna – Department of Management
June 27, 2016
We investigate stock return and trading volume reactions to analyst recommendation changes issued by local and foreign analysts for international stocks from 40 countries cross-listed in the U.S. We find that recommendation changes by analysts based in the U.S. lead to significantly higher abnormal returns and lower abnormal volumes in the home market of the cross-listed firm, compared to changes made by local analysts. Our results are robust to various controls, stronger for upgrades, and strengthened by an identification strategy that relies on analysts that move locations. We do not find supporting evidence of a certification role of U.S. analysts as we find a stronger effect for firms from countries with stronger legal, governance, and reporting environments. We also do not find evidence of a timing advantage of U.S.-based analysts or of local investor over-reaction to their recommendation changes..
Are U.S. Analysts’ Recommendation Changes For Cross-Listed Stocks More Informative Than Local Analysts’? – Introduction
Firms that cross-list in the U.S. tend to experience an increase in analyst following and usually have both U.S. and local analyst coverage after the cross-listing. Prior research has examined changes in analyst coverage and forecasts accuracy around cross-listing decisions (Lang, Lins, and Miller, 2003) and investigated the effect of the cross-listing on price and volume reactions to earnings announcements (Bailey, Karolyi, and Salva, 2006). Yet little is known about the role of informational intermediaries, such as analysts, located in the country of the cross-listing for the information environment of the firm and price discovery in the home market. For example, Karolyi (2006) observes that:
“To fully understand the economic consequences of changes in the disclosure requirements for firms listing shares on overseas exchanges, research needs to concentrate more efforts on the role that informational intermediaries play.[…] Unfortunately, little is still known about the composition of the analysts, whether they are local or based in the new market, and whether this affects the dispersion or accuracy of their forecasts or the capital market participant’s reactions to their forecast skills” (p.114).
Consequently, in this paper we examine the relative informativeness of U.S-based analysts’ recommendation changes compared to local analysts’ for international stocks cross-listed in the United States. One strand of the literature shows that analysts’ stock recommendations generally tend to be informative (Womack, 1996; Jegadeesh, Kim, Krische, and Lee, 2004) and that geographical distance has a negative effect on the accuracy of analyst earnings forecasts suggesting that local analysts have an information advantage (Malloy, 2005; Bae, Stulz, and Tan, 2008). Another strand of the literature, however, suggests that various monitoring mechanisms improve with a cross-listing and that overseas analysts might play a certification role for the home stock (Stulz, 1999). Thus U.S. analysts’ recommendations might be more informative than local analysts’ because information production might be more stringently regulated in the U.S. than in the local market or because Wall Street intermediaries command a higher perceived reputation alleviating informational and agency concerns of home market investors.
We investigate stock return and trading volume reactions to analyst recommendation changes issued by local and foreign analysts for international stocks from 40 countries cross-listed in the U.S from 2003-2007. We first examine home and U.S. market reactions to recommendation changes irrespective of the location of the issuing analyst. We find recommendation changes to be informative for both home and U.S. market investors, and find no significant differences in stock returns between the home and the U.S. market, but higher abnormal trading volumes in the home market. We next differentiate by the location of the analyst. Our main results show that recommendation changes by analysts based in the U.S. lead to significantly higher abnormal returns in both, the U.S. and the home market of the cross-listed firm, but that abnormal volumes are higher in the U.S. for recommendation changes from U.S. analysts and higher in the local market if issued by local analysts. We do not find such a differential effect for other foreign analysts.
We examine price and volume reactions as they allow us to identify information asymmetries and differential information processing among investors (Kim and Verrecchia, 1991, 1994). A price change at announcement of a recommendation change is proportional to the news in the announcement and the precision of the announcement. A volume change is proportional to the absolute price change and differential private information across traders. Our findings of a higher U.S. and home market reaction to U.S. analyst recommendation changes compared to local analysts thus suggests that investors perceive the U.S. analysts’ signal to be of higher precision (holding the magnitude of the change constant). The relatively lower abnormal trading volumes in the home market to U.S. analysts’ recommendation changes suggest that there is less disagreement among investors about the precision of the U.S. signal compared to that of a local analyst. That is, the recommendation news of U.S. analysts is relatively more important to home market traders due to less precise private information and thus has a larger impact on their beliefs.
We further find that the U.S. location premium to analyst recommendation changes is higher (and statistically more robust) for recommendation upgrades than downgrades. This result is consistent with the notion that agency costs might be higher for home market investors with respect to recommendation upgrades. If conflicts of interest are more pervasive between local analysts and local firms, which might mean that local analysts are more reluctant to issue downgrades or are more likely to issue upgrades for local firms, then investors will assign a higher U.S.-location premium to upgrades than downgrades.
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