A Direct Test of Private Information A Direct Test of Private Information on Analysts’ Recommendations:on Analysts’ Recommendations:

Examination of Profits among Institutions and IndividualsExamination of Profits among Institutions and Individualson Brokerages Recommendationson Brokerages Recommendations

Yu-Jane Liu K.C. John Wei Vivian W. Tai

戴維芯 Vivian W. Tai Department of Banking and Finance

National Chi Nan University

NTU International Conference on Finance Taipei, Taiwan

2006.12.14

Information ValueInformation Value of of Analysts’ RecommendationsAnalysts’ Recommendations

The information value of analysts’ researches is mostly recognized by cumulative abnormal returns.(e.g. Elton, Gruber ,and Grossman, 1986; Womack, 1996; Barber et al, 2001)

Behavioral Finance emphasize the differences among investors. (e.g. Barber, Lee, Liu and Odean, 2005)

Unfortunately, little researches focus on the information value of analysts’ research for types of investors, especially individual investors.

Trading behaviorsTrading behaviors of institutions and/or of institutions and/or individual investors on analysts’ information individual investors on analysts’ information

Chen and Cheng (2002): types of institutions

Iskoz (2003): institutions’ trading on underwriter’s and non-underwriters’ recommendations

Malmendier and Shanthikumar (2003): big traders tend to account distortion of affiliated analysts and small investors follow recommendations naively.

Lee, Liu, and Tai (2004): actual demands of five types of investors

The studies mentioned above have not further verified the exact reason for different trading behaviors between institutions and individuals.

WhyWhy do institutions and individuals react do institutions and individuals react differentlydifferently to analysts’ recommendations? to analysts’ recommendations?

Institutions’ long-term relationship with brokerages

» Goldstein, Irvine, and Kandel (2004): commission revenue

» Lim (2001): Information assess channel

» Lin and McNichols (1998), Michaely and Womack (1999), Malmendier and Shanthikumar (2003): underwriting business

» Kim, Lin and Slovin (1997), Lee, Liu, and Tai (2004): Indirect evidences of analysts’ information leakage.

Institutions’ superior ability than individuals

» Lee, Liu, and Tai (2004)

» Malmendier and Shanthikumar (2003, 2005)

ContributionsContributions This paper provide a direct measure, actual trading

profit, to measure who do really benefit from the information value of brokerages, which help us to clarify the impact of different trading behaviors between institutions and individual investors.

We classify type of investors into customers and non-customers to directly test the existence of private information provided by recommending brokerages, which help us to clarify the exact reason of different reactions between institutions and individuals.

Shed further light on information value of brokerages recommendations and the relationship between brokerages and their customers.

Three IssuesThree Issues1) Who does really benefit from analysts’

recommendations? • Individuals vs Institutions?

2) Do customers of recommending brokerages benefit from the private information provided by brokerages?

• Customers?

• Institutional customers?

3) Is the information value of institutions caused by clients’ relationships with brokerage houses or their superior selectivity?

• Profit differences among customers in mutual funds, corporations and individual investors are larger in customers than those in non-customers.

Data SourcesData Sources

Intra-day trading data from TSEC

Recommendation data collected reports from brokerages by Central News Agency.

Sample period: June 1996~Dec. 1999

Excluding recommendations which experience IPO, de-list, moving from OTC to TSE, covered less than 5 times, and brokerages which recommend less than 10 times.

» Number of recommendations: 56,655

» Event number of recommended day-stock: 33,919

» Number of recommending brokerages: 46

Empirical MeasurementsEmpirical Measurements Customers definitions:

» Investors who have been submitted orders from recommending brokerages are defined as customers.

Actual Trading Profit: » Revenue at each selling time deduct mapped cost and transaction

costs.» Mapped cost calculations: FIFO and Averaged methods» Excluding profit of short sale

• Short Sale restriction of institutions in Taiwan• Hedge instruments and derivatives market in not active• Optimal Rule of individuals investors• Limits to open margin account• Percentage of Short Sale is small• The largest percentage of sell recommendation is “Downgrade”

» Profits of type of investors: equal weighted and value weighted Recommendation characteristics:

» Rating: keywords mapping following Chang (2003)» Consensus score: Averaging the rating» Type: Initiate, Continuous, Upgrade, and Downgrade

ISSUE 1: Information Value of RecommendationsISSUE 1: Information Value of Recommendations-Table 2. Profits of Different Type of Investors

mean(%)

H0: profit=0

t-test p-value

mean(%)

H0: profit=0

t-test p-value

Panel A. Buy RecommendationsForeigners 13.24 37.95 *** 9.01 24.28 ***

Mutual Funds 8.02 51.54 *** 7.09 31.41 ***

Corporations 5.62 14.08 *** 3.84 32.31 ***

Individual investors 2.25 33.74 *** 1.58 47.48 ***

F-test 332.23***

299.64***

Panel B. Sell RecommendationsForeigners 11.07 11.93 *** 7.78 10.21 ***

Mutual Funds 5.75 12.17 *** 4.86 11.93 ***

Corporations 0.32 0.47 -1.46 -4.93 ***

Individual investors -0.61 -4.20 *** -1.82 -12.38 ***

F-test 75.78 *** 121.84 ***

FIFO method Average methodEvent Period t=[-15,+15] Event Period t=[-5,+5]

>0 >0

Largest

Smallest

Largest

Smallest

Largest

Smallest

Largest

Smallest

AdjustedAdjusted trading profit trading profit

t= -15 t= +15t=0

Buy(Cost)

Sell(Revenue)

Buy(Cost)

Sell(Revenue)

Actual trading profitActual trading profit

t= -15 t= +15t=0

Buy(Adjusted Cost)

Sell(Revenue)

Buy(Cost)

Sell(Revenue)

Buy: Profit of Previous holding

Buy:Profit of buy and sell during event period

Buy(Cost)

Sell(Paper Gain/Loss)Buy: Profit of buy and hold

Sell(Revenue)

Buy(Fictitious Cost)

Sell: Profit from avoiding loss

ISSUE 1: Information Value of ISSUE 1: Information Value of RecommendationsRecommendations-Table 3. Adjusted Profits of Different Type of Investors

N

Holdingprofits mean

(%)During profits

mean (%)No-sell profits

mean (%)

Total adj.profits mean

(%)

H0: profit=0

t-test p-value

Foreigners 42 2.97 1.83 32.84 5.68 41.90 ***

Mutual Funds 34 2.32 0.70 10.99 2.12 23.87 ***

Corporations 147 2.38 1.83 21.15 4.08 48.40 ***

Individual investors 43,463 1.78 0.59 5.96 1.02 19.02 ***

F-test 213.96*** 198.37*** 887.22*** 563.54***

N p-value

Foreigners 19 ***

Mutual Funds 21 ***

Corporations 96 ***

Individual investors 30,565 ***

F-test 1.98*

5.83 12.65

5.67 12.47

5.16 9.55

4.32 9.14

Panel A. Buy Recommendations

Panel B. Sell Recommendations

Adj. profits mean (%) H0: profit=0 t-test

>0

>0

ISSUE 2&3: Private Information ValueISSUE 2&3: Private Information Value -Table 6. Profits of Customers and Non-customers

mean(%)

H0: profit=0

t-test p-value

mean(%)

H0: profit=0

t-test p-value T-test p-value

Panel B. Buy Recommendations by Average methodForeigners 7.17 16.78 *** 9.88 32.03 *** -5.16 ***

Mutual Funds 10.00 11.29 *** 6.07 49.01 *** 4.39 ***

Corporations 4.31 25.32 *** 3.15 37.61 *** 6.12 ***

Individual investors 1.49 25.12 *** 1.62 48.74 *** -1.93 *

Total 1.51 28.68 *** 1.64 49.17 *** -2.03 **

Panel C. Sell Recommendations by FIFO methodForeigners 9.24 2.62 ** 11.10 11.93 *** -0.51Mutual Funds 12.85 3.70 *** 5.77 12.20 *** 2.02 *

Corporations 1.30 1.42 0.34 0.50 0.84Individual investors -0.60 -3.81 *** -0.60 -4.14 *** -0.02Total -0.63 -3.90 *** -0.59 -4.05 *** -0.16

Event Period t=[-15,+15]Customers Non-customers Diff. Test

5.695.69 8.51 8.51 2.92 2.92 4.45 4.45

ISSUE 2&3: Private Information ValueISSUE 2&3: Private Information Value -Table 7 & 8. Adjusted Profits of Customers and Non-customers

N

% ofinvestor

typemean(%)

H0: profit=0

t-test p-value N

% ofinvestor

typemean(%)

H0: profit=0

t-test p-value T-test p-value

Foreigners 11 29.53 5.57 33.42 *** 30 70.57 6.43 42.42 *** -3.79 ***

Mutual Funds 27 77.22 2.17 23.44 *** 6 22.88 4.06 26.16 *** -10.4 ***

Corporations 25 15.06 4.18 35.02 *** 120 84.95 3.91 46.95 *** 1.87 *

Individual investors 3,660 6.80 0.84 15.14 *** 39,743 93.19 1.05 19.55 *** -2.71 ***

Foreigners 7 31.82 5.06 6.94 *** 15 68.18 5.27 9.14 *** -0.22Mutual Funds 18 75.00 5.48 10.11 *** 6 25.00 5.81 12.56 *** -0.38Corporations 15 15.15 4.25 8.2 *** 84 84.85 4.53 8.82 *** -0.46

Individual investors 2,149 7.01 5.93 12.33 *** 28,492 92.99 5.67 12.46 *** 0.40

Table 8. Sell Recommendations

Customers Non-customers Diff. Test

Table 7. Buy Recommendations

Regression AnalysisRegression Analysis

To examine the relation between actual trading profits of investors and customer relationships, we ran profit regressions as follows,

(2)

____

__

__

171615

1413121110

9,8,7

,6,5,4

,3,2,10,,

kkk

k

kbikbi

kbikbikbi

kbikbibibki

turnRePastBMSize

RatingDTypeUTypeITypeCType

trunRePastCustomersBMCustomersSizeCustomers

RatingCustomersDTypeCustomersUTypeCustomers

ITypeCustomersCTypeCustomersCustomersofitPr

where,i is the type of investors, b is brokerages, including recommending brokerages, and non-brokerages.

k is the kth event for k=1, …, K.

Table 9. Profit Regression Analysis Table 9. Profit Regression Analysis in in buybuy recommendations recommendations

Intercept+Type_Continuous 27.80 *** 28.97 *** 13.05 *** 13.36 *** 14.06 *** 12.09 *** 3.75 *** 4.05 ***

Customers (dummy) -10.03 *** -24.16 ** -0.67 -12.84 -1.31 ** 4.86 -0.39 *** -1.00

Customers*Type_Initiate -3.03 -1.72 -1.69 0.27

Customers*Type_Upgrade -2.85 -2.93 -2.42 -0.09

Customers*Type_Downgrade -4.03 2.60 -2.12 0.44

Customers*Rating 1.40 1.47 -1.72 * 0.22

Customers*Size 0.01 ** 0.02 *** 0.01 ** 0.002 **

Customers*BM 23.60 *** 4.27 8.59 *** -1.35 ***

Customers*PastReturn -0.44 *** -0.02 0.10 ** -0.003

Type (dummy)

Type_Initiate -2.20 ** -1.76 * -0.89 ** -0.91 ** -2.96 *** -2.49 *** -1.49 *** -1.62 ***

Type_Upgrade 2.09 ** 2.64 *** 0.001 0.05 -0.76 0.17 -0.27 * -0.23

Type_Downgrade 1.87 2.56 ** 0.39 0.31 1.44 2.13 0.42 * 0.20

Consensus Rating -0.29 -0.40 0.39 * 0.35 0.49 1.02 * 0.20 ** 0.09

Size (1000million TWD) 0.03 *** 0.03 *** 0.02 *** 0.02 *** 0.01 *** 0.01 *** 0.02 *** 0.02 ***

BM -43.75 *** -46.00 *** -23.85 *** -23.97 *** -29.58 *** -31.98 *** -9.62 *** -8.95 ***

Past return (t=[-30,-16]) 0.45 *** 0.51 *** 0.41 *** 0.41 *** 0.28 *** 0.24 *** 0.15 *** 0.15 ***

adj. R-square 5.55 5.72 10.87 10.90 2.02 2.05 9.57 9.58

Foreignercoefficient coefficient

Individualscoefficient coefficient

Corporationscoefficient coefficient

Mutual Fundscoefficient coefficient

Intercept 13.26 *** 8.03 *** 5.69 *** 2.26 ***

Customers (dummy) -3.42 *** 4.65 *** 1.15 * -0.34 ***

adj. R-square 0.04 0.05 0.01 0.01

Foreigners Mutual Funds Corporations Individualscoefficient coefficientcoefficient coefficient

Table 10. Profit Regression Analysis Table 10. Profit Regression Analysis in in sellsell recommendations recommendations

Intercept 11.10 *** 5.77 0.34 -0.60 ***

Customers (dummy) -1.85 7.08 0.96 -0.003

adj. R-square 0.01 0.04 0.00 0.01

coefficient coefficientMutual Funds

coefficientForeigners

coefficientCorporations Individuals

Intercept+Type_Continuous 37.15 *** 37.59 *** 24.82 *** 24.63 *** 12.50 *** 15.61 *** -1.65 *** -1.16 *

Customers (dummy) -8.01 * -24.82 0.72 39.33 -3.61 *** -17.04 ** -0.42 ** -1.38

Customers*Type_Initiate 7.04 -2.43 6.95 0.68

Customers*Type_Upgrade 5.27 -13.61 -3.66 0.21

Customers*Type_Downgrade 6.59 2.84 1.03 *

Customers*Rating -2.98 -11.78 5.83 ** 0.38

Customers*Size 0.02 -0.005 -0.03 ** -0.004 *

Customers*BM 43.20 * -25.22 -5.39 -1.07 *

Customers*PastReturn -0.58 0.37 0.05 -0.04 ***

Type (dummy)

Type_Initiate -16.06 *** -16.16 *** -8.20 *** -8.23 *** -2.36 -3.49 * -1.23 *** -1.55 ***

Type_Upgrade -23.06 *** -23.07 *** -9.20 *** -8.76 *** -5.04 -3.63 -2.46 *** -2.58 ***

Type_Downgrade -11.22 *** -11.49 *** -5.15 *** -5.15 *** 0.47 0.02 1.86 *** 1.37 ***

Consensus Rating 1.50 1.57 -0.72 -0.66 0.79 -0.68 1.73 *** 1.54 ***

Size (1000million TWD) 0.05 *** 0.05 *** 0.02 *** 0.02 *** 0.01 ** 0.02 *** 0.02 *** 0.02 ***

BM -54.34 *** -55.36 *** -30.87 *** -30.82 *** -31.01 *** -30.02 *** -10.44 *** -9.96 ***

Past return (t=[-30,-16]) 0.81 *** 0.82 *** 0.56 *** 0.56 *** 0.34 *** 0.33 *** 0.15 *** 0.17 ***

adj. R-square 20.81 20.84 23.51 23.47 8.97 9.11 35.62 35.73

coefficient coefficientcoefficient coefficient(3) (4)

coefficient coefficient

Mutual Funds Corporations Individuals(3) (4) (3) (4)

Foreigner(3) (4)

coefficient coefficient

ConclusionsConclusions We document the information value of recommendations by

looking at actual trading profits. We find:

» All investors get positive benefits and significantly profit from brokerages’ buy recommendations.

» Professional institutions earn more profits than retail investors during the event periods, which supports that professional investors have superior selectivity and long-term relationship with brokerages.

To test the private information from brokerage houses, we separate types of investors into customer and non-customer based and find:

» Private information made their domestic institutional clients wealthier through buy recommendations.

» Controlling superior abilities of institutions, institutional customers earn more than institutional non-customers, which support domestic institutions get benefit from their deep relationship with brokerages.

» Our finding both supports institutions’ superior ability hypothesis and customer relationship hypothesis.