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Analysts' Selective Coverage and Subsequent Performance of Newly Public Firms

Authors

  • SOMNATH DAS,

  • RE-JIN GUO,

  • HUAI ZHANG

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    • Das and Guo are at the University of Illinois at Chicago, and Zhang is at the University of Hong Kong. We thank Eli Amir, Gilbert Bassett, Oleg Bondarenko, Konan Chan, Hsiu-lang Chen, Tim Kruse, Chao-Shin Liu, Malcolm McClelland, Roni Michaely, Tom Nohel, Ram Ramakrishnan, Cathy Schrand, Abbie Smith, Lenny Soffer, Wei-Ling Song, Robert Stambaugh (Editor), Steve Todd, Beverly Walther, Nan Zhou, an anonymous referee, and seminar participants at the City University of Hong Kong, Indiana University at Indianapolis, the London Business School, Nanyang Technological University, the Office of Economic Analysis at the U.S. Securities and Exchange Commission, Singapore Management University, Syracuse University, University of Illinois at Chicago, the 2003 Eastern Finance Association Meeting, the 2003 Midwest Finance Association Meeting, and the 2004 National Taiwan University International Conference on Finance for their helpful comments and suggestions. This paper received a “Best Paper Award” at the 2004 National Taiwan University International Conference on Finance. The authors gratefully acknowledge the contribution of Thomson Financial for providing forecast data through I/B/E/S. These data are provided as part of a broad academic program to encourage earnings expectations research. All errors remain ours.

ABSTRACT

This study examines the ability of analysts to forecast future firm performance, based on the selective coverage of newly public firms. We hypothesize that the decision to provide coverage contains information about an analyst's underlying expectation of a firm's future prospects. We extract this expectation by obtaining residual analyst coverage from a model of initial analyst following. We document that in the three subsequent years, initial public offerings with high residual coverage have significantly better returns and operating performance than those with low residual coverage. This evidence indicates analysts have superior predictive abilities and selectively provide coverage for firms about which their true expectations are favorable.

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