Is there life after loss of analyst coverage?

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New York, NY – According to a recently published research paper (April, 2007), the impact of losing analyst coverage on small and mid-sized publically traded firms is significant, with 29% of the sample firms used in the study delisting within 2 years of losing coverage, and another 34% delisting between 2 to 5 years after losing coverage.  This compares to an incidence of 17% of companies delisting which maintained their research coverage over both periods mentioned above.

The academic study, titled “Is there life after loss of analyst coverage?” was written by Ajay Khorana of Georgia Institute of Technology, Simona Mola of Arizona State University, and P. Raghavendra Rau of  Purdue University.

Based on a sample of 2753 firms that lost analyst coverage between 1983 and 2004, the authors tried to determine why these firms lost their research coverage.  In addition, the authors evaluated what happened to these firms after they lost all of their research coverage.

The study found that research analysts tended to drop coverage of poorly performing firms as they have historically been loath to issue negative recommendations for companies under coverage.  Also, companies that have “Sell” recommendations tend not to generate a significant amount of commission dollars for an investment bank (although hedge funds are interested in these ideas).

In addition, the study found evidence that past investment banking revenue, and the likelihood of near-term banking deals were reasons that were supported by their analysis.  In other words, this study suggested that investment banks arew strategic in deciding how to utilize their limited research resources.

While this study did not reveal anything surprising, it was one of the first academic papers to assess the impact of losing research coverage on publically traded companies and tried to come up with rationale for this loss of coverage that could be supported by a rigorous analysis.

In addition, we feel that this study is important as it should contribute to the industry debate of how best to promote research coverage for all publically traded companies — particularly given the fact that the current business model supporting small cap research is irreversibly broken.

Unfortunately, most private efforts to boost research coverage for under covered and uncovered companies (including the Independent Research Network and the National Research Exchange) have not achieved significant traction as managements of small cap companies have been reticent to pay for research coverage for a variety of reasons (the questionable credibility of the research and the hope that their firms would get picked up by boutique investment banks).

An electronic copy of this paper is available here.

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