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1 February 2013 CFA Institute Journal Review

Do Star Analysts Know More Firm-Specific Information? Evidence from China (Digest Summary)

  1. Butt Man-Kit, CFA

Stock returns in emerging markets generally show high synchronicity. Using a unique database in China, the authors show that star analysts provide more firm-specific information than nonstar analysts. Therefore, firms that are covered by more star analysts incorporate greater firm-specific information and have lower synchronicity in their stock returns than other firms. Star analysts also produce more-accurate earnings forecasts than nonstar analysts.

What’s Inside?

Using the list of star analysts published by New Fortune, the authors determine the information-production role of star and nonstar analysts. The results indicate that security analysts are not homogeneous and that their ability to produce firm-specific information can vary greatly. Star analysts’ superior firm-specific human capital helps them overcome the challenges of information production in emerging markets.

How Is This Research Useful to Practitioners?

Financial analysts generally agree that in an efficient market, stock prices reflect price-sensitive information, both firm-specific and marketwide. But if the transparency of firm-specific information is low in a specific market, stock prices may largely reflect marketwide information but not firm-specific information. In such a market, stock prices move together more and thus have high stock return synchronicity.

Stock return synchronicity is greater in emerging markets than it is in developed markets. The authors conjecture that this disparity is a result of less firm-specific information production happening in emerging markets because of capital market impediments. Compared with developed markets, emerging markets are generally more opaque and less open, with worse legal or property rights protection. Previous researchers have also shown that greater analyst coverage increases stock return synchronicity, and they have concluded that the information collected by a security analyst contains more marketwide content than firm-specific information.

The authors replicate the previous research with data from China. They confirm the general conclusion that there is a positive association between analyst coverage and stock return synchronicity in the Chinese market. But they extend their study by investigating whether star analysts produce different information from nonstar analysts. They find that star analyst coverage actually decreases stock return synchronicity. In terms of earnings forecast accuracy, star analysts perform better than nonstar analysts. The authors contend that star analysts’ superior firm-specific human capital helps them overcome the challenges of information production in an emerging market.

The findings are important to practitioners because they confirm that star analysts know more firm-specific information, which helps decrease stock return synchronicity. Also, the authors find evidence that analyst coverage (especially star analyst coverage) can produce useful firm-specific information instead of firm-specific noise.

How Did the Authors Conduct This Research?

The authors use data from 2003 to 2010. They start with 2003 because it is the first year in which star analysts were selected by New Fortune, a financial magazine in China that creates and publishes annually a list of star analysts. They use the China Stock Market and Accounting Research (CSMAR) database as the primary source for analysts’ earnings forecasts, stock returns, and financial data.

To calculate analyst coverage, the authors use information about analysts’ covered stocks and earnings forecasts for specific firms. Then they calculate analyst coverage by firm-year group and obtain 7,200 firm-year observations that are covered by analysts. They combine analyst coverage with the stock return synchronicity for each stock in a particular year along with other control variables in the same year. The final sample has 10,326 firm-year observations, and 5,510 of them are covered by at least one star or nonstar analyst.

To measure an analyst’s experience, the authors use two values—the number of years the analyst has been forecasting and the number of forecasts the analyst has produced. An analyst’s experience is categorized as general, industry, or firm specific.

The authors run regression models on (1) analyst coverage and stock return synchronicity, (2) star analyst coverage, nonstar analyst coverage, and stock return synchronicity, and (3) analysts’ experience and stock price synchronicity.

Abstractor’s Viewpoint

The authors confirm that star analysts know more firm-specific information and make more-accurate earning predictions than nonstar analysts. Those firms covered by star analysts also have lower stock return synchronicity. The findings will be helpful for practitioners making investment decisions. The results also reveal that financial analysts help improve information efficiency instead of producing firm-specific noise.

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