Evidence that Price Leads of Earnings Increase with Analyst Following and Institutional Ownership

Abstract

This paper presents evidence that prices of firms followed by sell-side analysts and favored by institutional investors incorporate future earnings earlier than prices of other firms. Our tests are based on regressions of year t abnormal returns on earnings changes from years t-1, t, and t+1. We find that lead coefficients for firms most heavily followed by analysts or favored by institutions are greater than lead coefficients for firms with little analyst following or institutional holdings. In contrast, contemporaneous coefficients for analyst and institutional favorites are less than contemporaneous coefficients for other firms. Furthermore, the results for analysts and institutions are incremental to each other. In addition, neither effect is due to the fact that price leads are an increasing function of firm size.

One possible explanation for our results is that market professionals are more skilled than other investors in analyzing publicly available information. Alternatively, the positive association between price leads and professional interest may exist only because management provides more detailed information to sell-side and buy-side analysts than to individual investors. This possibility prompted the SEC to issue Regulation FD, which creates a more level playing field for all investors by eliminating selective disclosures. Our results, which are based on data prior to the passage of Regulation FD, suggest that the "distribution gain" sought by the SEC may come with an "allocation cost." That is, if Regulation FD causes management to reduce the flow of information to market professionals, the length of price leads could be shortened.

JEL Classification: G12, G14, G29, G18, M41