New Study: Paid-For Analyst Reports Can Benefit Investors

Recently published research by three accounting professors found that reports from paid-for stock analysts offer nearly the same relevant information to investors as reports from sell-side firms.

Their analysis of 247 paid-for reports showed that “the recommendations and forecasts supplied by paid-for research firms provide value-relevant information for the buy-and-hold investor." It also affirms recommendations by the US Securities and Exchange Commission (SEC) Advisory Committee that support paid-for research “as a means of filling the void left by declining side-sell analyst coverage,” according to the research paper, Worth the Hype? The Relevance of Paid-For Analyst Research for the Buy-and-Hold Investor, which will be published in the May/June issue of The Accounting Review, a journal of the American Accounting Association.

Wall Street stock analysts have often gotten a bad rap because they “rarely say ‘sell,’ and their research reports often are compromised by investment-banking relationships or other conflicts of interest,” Bloomberg View columnist Jonathan Weil wrote on May 8 in a post about the accounting professors’ findings.

But the study’s authors – Bruce K. Billings of Florida State University, William L. Buslepp of Texas Tech  University, and G. Ryan Huston of the University of South Florida – failed to find “significant differences in the quality of paid-for analyst research relative to matched sell-side analyst research in terms of bias, accuracy, or ability to distinguish favorable from unfavorable future performance.” Their results suggested that paid-for research “offers potential benefits to investors in small- and mid-cap equity markets.”

In their study, the professors looked at what distinguishes paid-for research from investor-relations reports.

“Investor-relations reports may have the look of genuine research documents, but they are essentially public relations or marketing exercises,” Billings noted. “By paid-for research, we refer specifically to outfits that can make a legitimate claim to independence, even though they are paid by the firms that are the subjects of their reports. In that way they are like credit-rating agencies, which are paid by companies to evaluate their debt, or auditors, who are paid by companies to certify their financial reports.”

Buslepp added that paid-for outfits tend to have explicit rules; for example, that the client may not prevent the publication of an unfavorable report or withdraw from coverage before the expiration on the agreed-on term.

“They may have rules against holding or trading in a client's stock – although there are unfortunate exceptions to this – and may require lump-sum cash payments up front,” he said. “They are also more likely than investor-relations firms to emphasize their analysts' experience or credentials in finance."

In addition, as the paper notes about paid-for research firms, “Although contractual arrangements permit the client to review the analyst report for factual errors, analyst recommendations and forecasts are withheld from the report.”

The analysis of 247 paid-for reports was matched with the same number of reports produced by sell-side firms. Matching was based on an array of essential features of client firms such as the following:

  • Size
  • Age
  • Earning volatility
  • Book-to-market ratio
  • High-tech status
  • Research and development intensity
  • Percentage of shares held by institutions

Reports were assessed in terms of the bias and accuracy of earnings forecasts for periods of up to two years and by how analyst recommendations – ranging from strong sell to strong buy – squared with stock performance over periods extending from a day to a year following report release dates.

Comparing earnings forecasts with actual results, the professors reported that for both one- and two-year forecasts, they failed to find that paid-for analysts exhibited either optimism or pessimism bias and “results for tests of paid-for forecast accuracy are similar.” While findings for sell-side analysts were practically the same, the paid-for group actually had a slight edge on accuracy in their two-year forecasts.

“While investors appear to initially respond more quickly to sell-side research, longer-window returns suggest that paid-for research does not reflect significantly lower quality in distinguishing future performance than matched sell-side research,” the study noted.

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