(September 17, 2012) — Changes in analysts’ price targets do, in fact, predict institutional trading, according to an academic paper by two Canadian professors.
The paper — written by Shannon Lin, a professor at Queen’s University, and Hongping Tan, a professor at the University of Waterloo — further notes that the analysis shows that the positive relation between institutional trading and target price changes is more pronounced for small firms, which generally have lower trading volume, and is limited to more active institutional investors.
In recent years, analysts have increasingly included target prices alongside earnings forecasts and stock recommendations in their research reports, conveying analysts’ assessment of the expected value of underlying stocks. The usefulness of such research is a hotly debated topic. While some investors point to the wealth of information contained in such research, “there is considerable concern over the objectivity and investment value of analyst research given the conflicts of interest problems surrounding the securities research industry,” the paper notes. “Essentially, analysts have been accused of positively biasing their opinions to attract investment banking business, to secure management access, and to generate brokerage commissions.”
In order to study whether institutional investors trade in the same direction as target price changes, the authors used a sample of analyst target price forecasts for 6,415 US firms from 1999 to 2011. The authors explain whether institutional investors trade on the information contained in target price changes and identify factors that moderate the impact of target price changes on institutional trading.
According to Lin and Hongping, the research has important implications for market regulators. The research “fails to find a stronger reaction from institutional investors to target prices after the series of regulations introduced in the early 2000s to better discipline the security research industry,” it concludes.