New York – A recent paper was published in December 2007 by two professors at the Stern School of Business, New York University. The title is “The Value of Research“. The authors are Bryan Kelly and Alexander Ljungqvist.
Everyone admits to feeling that research ought to add value to a company, but it is difficult to get a sense of how much value that might be. The authors examine the measurement of the value added, by looking at coverage terminations. Granted this assumes that the price reaction for getting or losing coverage is symmetrical, but this is a modest assumption to make for the clarity of the data set.
The major findings of the paper are two-fold: First, the paper finds that “on announcement that a stock has lost all coverage, share prices fall by around 110 basis points or $8.4 million on average. The authors also tested whether there was a bounce-back in the share price within 1 month, 6 months and 24 months and found that the loss appears to be a permanent loss of value. Second, the reduction in coverage hurts the small institutions and individual investors more that it does large institutional investors.
Of course you have already discounted the results by thinking through the process of dropping coverage at your own shop. Typically, a firm will drop coverage when a company is looking negative by its assessment. Conversely, a research firm does not typically pick up coverage on stocks they think are duds. The authors term this type of termination of pick up as an endogenous change in coverage. Because of the bias in endogenous coverage changes they were removed from the data set before estimation.
Starting from a sample of 16,253 coverage terminations, the authors chose 838 coverage drops where the firm lost all coverage and where the drops were a result of brokerage closures, where the odds that the dropped coverage was related to the performance of the companies is minimal.
Perhaps the most interesting aspect of the report is assertion that actions taken to protect investors over the past several years, which aimed at reducing the conflict of interest in the sell-side research model, may have also accrued a permanent macroeconomic cost to society.
Source: The Value of Research, December 2007,
Bryan Kelly, Stern School of Business, NYU,
Alexander Ljungqvist, Stern School of Business, NYU