Academic journal article Indian Journal of Economics and Business

A Study of the Timing of Initial Analyst Coverage of Initial Public Offerings

Academic journal article Indian Journal of Economics and Business

A Study of the Timing of Initial Analyst Coverage of Initial Public Offerings

Article excerpt

Abstract

For a sample of 1,758 initiations of analyst coverage on 448 IPOs issued during 1997 and 1998, I find market reaction to a recommendation varies with the timing of its release. The later the initiation of coverage with a buy recommendation the more pronounced the market reaction. Since "early" initiations of coverage are dominated by analysts affiliated with the managing underwriters and "late" initiations are dominated by unaffiliated analysts, previous findings of a conflict of interest effect appears to be related more to the timing of the coverage rather than the banking relationships of the analysts.

Introduction

The timing of a recommendation can potentially influence the success of its subject. An endorsement of a political candidate in the days leading up to an election would be fresher in voters' minds than an endorsement released months earlier. A positive review on a restaurant when it first opens could establish a significant customer base before operating costs become too high. Finally, studio executives would much prefer a good review of their movie when it is opening in 3,000 theaters rather than six months later when it is only running on cable television.

The first year that an initial public offering trades, hereafter the IPO aftermarket, is another setting where the timing of a recommendation could influence the success of its subject. Previous research finds that analyst recommendations on initial public offerings (IPOs) influence stock performance. These studies, however, either do not address the timing of recommendations or determine it has no impact on IPO stock performance (for examples see Michaely and Womack (1999), Dunbar, Hwang and Shastri (1999), Carter, Piwowar and Strader (2002) and Bradley, Jordan and Ritter (2003)).

This paper analyzes 1,758 initiations of analyst coverage released on 448 IPOs issued in 1997 and 1998 to determine if investor reaction to a recommendation is affected by when analysts initiate coverage. The reason the timing of analyst coverage could influence IPO stock performance is because of the structure of the IPO aftermarket. According to Chen and Ritter (2000) and Michaely and Womack (1999), investment banks and issuing firms implicitly bundle analyst coverage into the underwriting contract. Because of security regulations, however, analysts affiliated with the managing underwriters, hereafter affiliated analysts, cannot initiate coverage until at least 25 days into the aftermarket. If investors are aware of the implicit coverage contract and anticipate affiliated analysts will initiate coverage as soon as restrictions are lifted then early affiliated recommendations may not have as significant an impact as later coverage.

Consistent with an implicit coverage agreement affiliated analysts frequently initiate coverage on their IPOs and do so early in the aftermarket. Affiliated analysts initiate coverage an average of five weeks after the offer date; six months earlier than the average initiation from unaffiliated analysts. Omitting the 14 issues that do not have research-active underwriters, 97% of the sample receives at least one affiliated analyst initiation during the aftermarket, and 80% of the IPOs receive coverage from all of their affiliated analysts. It appears that if the market is expecting early affiliated analyst coverage they are rarely disappointed.

I find that buy recommendations released at least two months after the offer date, defined as "late" initiations, have a greater impact on IPO stock performance than those issued within the first two months, defined as "early" initiations. Late initiations of coverage with a buy recommendation generate an average three-day market-adjusted cumulative return of 2.19%. This is significantly higher that the average three-day return of -0.03% for an early buy recommendation. I do not find any evidence that the significant late event returns are reversed in the week after the recommendation. …

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