In this paper, we investigate the relationship between sell-side reports, stock returns and trading volume in the Norwegian stock market, based on the OBX Index constituents1 as of June 30th, 2021 (Euronext, 2021). The OBX Index is an index that features the 25 most liquid stocks on the Oslo Stock Exchange and is revised semi-annually. The basis for investigating such relationships is to identify whether analysts provide value-add to their employer and investors.
Securities research is a discipline within the financial services industry, primarily divided into equity- and credit research2. Equity research analysts cover commonly traded stocks, whereas credit research analysts cover fixed income securities. Securities research can be classified as either sell-side or buy-side research. The focus throughout this paper will be on sell-side research.
Sell-side equity research analysts3 work on the sell-side of the capital markets, and they are predominantly employed by investment banks and other advisory firms mandated by companies to aid in capital markets transactions or to provide other types of advisory services for a client. Although a sell-side analyst’s role is composed mainly of analysing companies and issuing reports, there are some differences in the analyst’s role depending on whether it is a primary market transaction or if the securities are trading in the secondary market.
Sell-side equity research analysts are often conferred on transactions that the advisor assists during a primary market transaction. However, they are separated from the firm’s investment banking division to provide non-classified information to the investors. When this is the case, the equity research analyst will be given a detailed run-through by the investment banking team and the issuing agent to be as informed as possible and convey meaningful information to investors where applicable. However, equity research analysts are more frequently observed and encountered in the secondary market. Analysts will typically cover a range of companies within a specific industry that they analyse. An analyst will start coverage of a new firm by issuing an Initiation of Coverage (IoC) report, proceeded by updates/revisions to this report when the company releases interim and annual statements and various events of importance
1 OBX constituents referred to as “sample companies” throughout the paper.
2 Credit research can also be referred to as Fixed Income research.
3 Sell-side equity research analysts are referred to as “analyst”, “sell-side analyst” and “equity research analyst”
throughout this paper.
(firm-specific news). In most cases, these reports include an earnings estimate, a valuation range, a target price, and a purchase recommendation4 for the company.
Although reports issued by analysts may merely be conceived, by some, as guidance for investors, academic papers show that analysts play an essential role for the companies they cover in the capital markets. Merton (1987) argues that equity research analysts can contribute to lowering a company’s cost of capital, which leads to a higher stock price, by increasing the overall recognition of the company among investors. Merton builds on the assumption that there is an equilibrium in the market, where low-demand stocks trade at a lower price due to investors holding stocks they are familiar with. Analysts play an essential role in promoting companies to investors, and according to Merton, they actively contribute to increasing the firm value for the companies they cover. Numerous academic studies find the same negative relationship between investor recognition and cost of capital, for instance, Richardson et al.
(2012) and Huang & Wei (2012).
Groysberg et al. (2011) found, by analysing proprietary compensation data provided by a leading U.S. investment bank and research reports between 1988 and 2005, that analysts’
compensation is closely tied to their ability to sell securities on behalf of their bank’s sales force (brokers) and investment banking business. However, other factors influence their compensation, such as ratings based on their accuracy.
To investigate whether there is any value-add from sell-side reports concerning the OBX Index constituents, we examine whether these reports have any material impact on the sample companies in terms of stock returns and trading volume. In this study, we have deemed trading volume the primary determinant of investor recognition, whereas returns are the primary determinant of value-add to investors. We make an essential assumption that the same relationship between compensation and analysts’ ability to sell securities, as presented by Groysberg et al. (2011), and the cost of capital contribution found by Merton (1987) holds for analysts operating in the Norwegian market. The rationale for this thinking is that increased trading volume leads to higher compensation for the analyst, and it implies a heightened investor interest in the stock, whereas returns display the value-add for investors if the investor follows the analyst recommendations.
4 Common recommendations are “buy”, “hold” and “sell”, but can also include other variants and additional recommendations such as “strong buy” and “strong sell”.
Based on our observations, we believe that investors operating in the Norwegian stock market are more likely to read or observe analyst recommendations either through their broker or through the Norwegian financial press than those who are not. As such, we find that the Oslo Stock Exchange and the recommendations of select analysts covering the OBX Index constituents to be a valid starting point for exploring such relationships.