When they say it does matter: A study of analyst coverage on initial public offerings

The value of equity research has been in question since the early 1980's. Nevertheless, it was almost two decades until regulators began to question the relationship between an analyst's recommendation and their bank's affiliation with the recommended firm. Previous research finds that investors account for potentially biased research due to investment-banking ties. Investors appear to have a stronger reaction to recommendations from analysts not affiliated with the lead underwriter, but these studies do not examine the impact of when an analyst initiates coverage.; There are two reasons why the timing of analyst coverage should influence the market's response to stock recommendations. The first reason is that the further the recommendation is from the initial public offering (IPO) date the more likely that the analysis will contain information not disseminated during the registration period. The second reason for a timing effect is that initiations made by analysts affiliated with the underwriters could be understood by investors to be the fulfillment of an implicit contract to initiate positive coverage on their IPOs, and that these analysts will fulfill their obligation early in the IPO aftermarket. Thus, my hypothesis is that investor reaction is stronger to analyst research initiated later in the IPO aftermarket because later coverage is more likely to have new information and is not anticipated by investors.; Analyzing initiations of analyst coverage on 405 IPOs issued from 1997 to 1999, I found analysts affiliated with the underwriter initiate coverage, on average, 24 trading days after the offer date while analysts unaffiliated with the offering wait an average of seven months before issuing a recommendation. Controlling for this difference in timing, I found no evidence that investor reaction to buy recommendations depends on underwriting relationships. Independent of conflicts of interest, however, my tests uncover a positive timing effect. Buy recommendations released at least two months after the IPO generate an average market adjusted cumulative return of 2.43% compared to -0.20% for a recommendation that is released within two months of the IPO. These findings suggest that investor reaction to analyst coverage on IPOs is more complex than previous studies suggest.