The Value of Analyst Reports

[Sponsored Article]

Analyst Information Discovery and Interpretation Roles: A Topic Modeling Approach
HUANG, Allen | LEHAVY, Reuven | ZANG, Amy | ZHENG, Rong
Management Science, forthcoming

When a firm discloses important corporate information, analysts are usually right on their tail with reports about what was said. A new study has confirmed that these reports serve a valuable function for investors because they interpret, flesh out and confirm managers’ statements.

The study, by Allen Huang, Reuven Lehavy, Amy Zang and Rong Zheng, used an algorithmic model to analyse the language and topics discussed in firm conference calls on quarterly earnings and analysts’ reports on these calls. They then looked at investor responses. Their dataset included 17,750 conference calls by S&P500 firms from 2003-12 and 159,210 analyst reports on these calls.

The authors found analysts played two key roles that were valued by investors. On the one hand, they were agents of information discovery when they included new information about the firm through their private research based on such efforts as private interactions with firms’ top and middle managers, collating information from peer firms, governments and other sources, and visiting stores and warehouses to investigate supply chains and survey customers.

On the other hand, analysts played an information interpretation role by cutting through ambiguous or uncertain language by managers, highlighting points that the analyst considers to be important, and providing assessments of manager statements. All of this can lower investors’ costs in processing information.

“We found analysts spent on average 31 per cent of their discussion on exclusive topics that received little or no mention by managers, and 69 per cent focusing on conference topics. This suggests analyst information discovery and interpretation roles are both substantial,” the authors said.

While investors were found to respond positively to the reports, there were different circumstances in which the different kinds of analyst input were more valued. Investor reaction to information discovery was more pronounced when managers faced greater incentives to withhold value-relevant information, such as when firms had greater proprietary costs or faced a higher litigation risk, and when firms had experienced a bad performance.

Investors reacted more strongly to the information interpretation role when the conference call contained a greater amount of uncertain or qualitative statements or did not document bad news.

“We also found that within the 69 per cent of discussion in reports where analysts interpret conference call topics, 23 per cent of such discussion did not entail a different vocabulary than that used by managers in the call – in other words, the analysts sometimes simply confirmed managers’ statements.

“Interestingly, investors valued such confirmation, albeit to a less extent than analyst discovery or interpretation using the analyst’s own language. This is consistent with the idea that analysts provide confirming value to the relevance of topics and the credibility of the manager’s statements,” they said.

“Overall, our study shows that analysts play the information intermediary roles by discovering information beyond corporate disclosures and clarifying and confirming corporate disclosures.”