The recommendations of sell-side financial analysts play a big role in the decision-making process of investors (Clement and Tse 2003). The investor base includes fund managers, buy-side financial analysts, and both individual and institutional investors. Sell-side financial analysts (SSFA) are considered as an essential part of the capital market and an influential source of information to investors. Therefore, “[financial] analysts may be viewed as either representing or influencing investor beliefs.” (Lang and Lundholm 1996: 468)
Upon completion of earnings forecast analyses and formulating views about the covered companies, SSFA publish their stock recommendation reports to concerned investors. “An analyst’s report summarise the information used by the analyst in his work and explain how these influenced his valuation and buy/sell recommendation.” (Hussainey and Walker 2008: 3)
However, recently, there has been a lot criticism over the current reporting model including the information provided by companies to investors and stakeholders, and the extent to which audit should be associated with that information. One of the earliest vocals of such criticism was the Jenkins Report (AICPA 1994), which emphasized the need for information beyond the financial statements. According to the report by the AICPA
“In particular, financial statements are viewed as an excellent framework for capturing and organizing financial information. Users have welcomed improvements in business reporting, but few suggest the current framework should be scrapped and a new one developed. Yet many users are strongly critical of certain aspects of today’s reporting. Understanding the reasons for the criticism — much of it substantive — has identified high-priority areas for improvement. Some companies, particularly the larger ones, already provide all the information that users need, but many do not. Those that do, provide it in a variety of ways rather than in a comprehensive, integrated format.”
(1994: Chapter 1)
Because of the slow steps taken by the financial reporting community, information providers such as SSFA took it upon themselves to collect variety of information to reach their recommendation. However, since the SSFA reports are not audited or scrutinised by any reporting regulation it is still not clear what types of information SSFA use.
Through following a content analysis approach in examining SSFA reports, this study has four main objectives. First, identify the types of information conveyed in the equity research report provided by SSFA for UK companies. Second, examine recent claims that the current reporting model is better suited for traditional companies or TC (e.g. manufacturing firms) as opposed to new companies or NC (e.g. information firms). Since tangible assets and intangible assets are the main value drivers to traditional and new companies respectively (Abdolmohammadi et al. 2006; Upton 2001) following the approach employed by Abdolmohammadi et al. (2006), I will compare the content of the research reports for tangible asset intensive companies and intangible asset intensive companies in the UK. Any variation in the information retained in the SSFA research reports suggest that investors need different information when analyzing NC as oppose to TC. Third, study the impact of the accounting standards switch from Generally Accepted Accounting Principles (GAAP) to International Financial Reporting Standards (IFRS) on the investment analysis process in the UK using SSFA reports. Therefore, I will compare the content of the research reports for companies during the GAAP standards and IFRS standards for the same company. If analysts believe that the accounting standard switch is irrelevant to the investment analysis, then the types of information contained in the SSFA reports should not vary considerably during each standard. Forth, identify the possible sources of the information conveyed in the equity research report provided by SSFA for UK companies. Following the approaches introduced and utilized by Rogers and Grant (1997) and Abdolmohammadi et al. (2006), I will also trace the information (financial, and nonfinancial) contained in the SSFA reports with regards to current annual report filings for each company, thereby assessing the percentage of information traced back to the company’s financial statements and that traced to other sources. Therefore, I will be able to arrive at a conclusion on whether SSFA provide a broader range of information than that on the financial Statements.
One of the early studies concerning the information content of the analyst reports was conducted by Govindarajan (1980). In his study, Govindarajan used content analysis to analyst reports in order to determine the frequency of the usage of cash flow and earnings. He concluded that analysts generally use earnings information more often than cash flow information. In addition, he discovered that the industry of the company covered influenced the analyst choice between cash flow and earning analysis.
Previts et al. (1994) examined 479 reports of SSFA using word and phrase count approach. They found out that income statement and performance related discussions dominate the analyst reports, with balance sheet and other accounting factors less apparent. This is in line with Govindarajan’s (1980) conclusion about earning information usage and support linkage of security pricing with earnings. They also, found out that the analyst reports contain a considerable nonfinancial component including market share, competitive position, company history and its products.
A study more related to this research was one conducted by Rogers and Grant (1997). The research study was patterned after a content study methodology to analyze the content of 178 of SSFA research reports on manufacturing and retail US firms using sentences and phrases to classify the information in these reports. Unlike previous questionnaire and interview based studies, results of content-based studies are not influenced by the study method. In their study, they coded the entire report into “information units”, and identified them under six different broad categories. Then, they traced each information unit to their own source in the annual report. Rogers and Grant (1997) found that just over half of the coded information could be traced to the annual report. However, only a small percentage of the units, that is 26 percent, are traced back to the GAAP financial Statements with balance sheet and statement of cash flow being the least.
Breton and Taffler (2001) assessed the importance of the accounting information compared to qualitative (nonfinancial) information such as quality of management and firm strategy. They explored the factors that influenced SSFAs’ recommendations through a content analysis study using 105 reports of UK analysts. First, they classified the information contained in the analyst report in different categories with occurrence frequency being as the measure of importance. Then they linked these categories with the recommendations (buy, hold, and sell). They concluded that financial analysts rely on non-financial, soft, qualitative and imprecise information when forming their stock recommendations.
A recent study by Abdolmohammadi et al. (2006) identified the types of information contained in the SSFA reports. They use a sampled of 64 reports from US companies drawn from four different industries, and then classified them into two groups. The first group is the tangible-asset-intensive industry group including auto manufacturing and auto parts and textile and apparel. The second is the intangible-asset-intensive industry group including internet and telecommunications and network equipment. They found out that analysts covering companies under the intangible-asset-intensive sector tend to focus more on nonfinancial information than on financial data. Additionally, after coding the report and dividing the elements into financial and nonfinancial information elements, just over half of the financial elements and less than half of the nonfinancial elements was traced to the annual report.
Data and Methodology:
I will use the Thomson Research Ivestext database as the primary source of data for this study. Invest text described itself as containing “research reports written by top analysts at over 1,000 leading investment banks, brokerage houses, and consulting firms worldwide. Nearly 4,000 new reports are added each business day.” Brokerage houses include ABN AMRO, BNP Paribas Securities and Credit Suisse. I will also use the following sector grouping to conduct my study:
1) Aerospace and Defence, Automobiles, Construction and Building Materials, Mining, Oil and Gas, Steel and other Metals.
2) Electronic and Electrical Equipment, Information Technology Hardware, Pharmaceuticals, Software and Computer Services, and Telecommunications Services.
The first sector group represent the TC, in which the value-driving factor relies heavily on the manufacturing process. Therefore, they have considerably more tangible assets than intangible assets. On the other hand, companies in the second sector group represent the NC in which value generation depends primarily on intellectual capital and technology
Due to time limitation and the time-consuming process of parsing and coding, the study will be based on a relatively sample size of SSFA reports. Using Investext databases, 15 comprehensive SSFA reports (6,000 to 20,000 words) on publicly traded companies listed in the FTSE 100, between the years 2006 and 2008, shall be downloaded for each sample. Another 15 comprehensive SSFA reports on the same publicly traded companies, in both groups, between the years of 2003 and 2004 shall also be downloaded. FTSE 100 index “contains the 100 most highly capitalised blue chip companies, representing approximately 81% of the UK market (London stock Exchange)”.
In order for a research report to be included in the sample, the comprehensive report must be issued immediately after the issuance of the company’s annual report. When more than one brokerage house publishes a report that meets the selection criteria, one report shall be selected randomly. For samples between 2006 and 2008, five reports in each year are chosen. For samples between 2003 and 2004, seven samples from 2003 and 8 samples from 2004 are chosen.
To conduct the first three parts of the study, the full text of the analyst report will be broken into sentences and each sentence will be coded under either Information Category or Interpretation Category. The Information Category will include five main elements such as the Financial and Nonfinancial, Management’s Analysis, Forward-Looking Information Management and Shareholders, and Background Information about the Company and Industry. The Interpretation Category will include Processing Steps, and Conclusions. To conduct the fourth part of this study, I will focus on major information that relates to the past performance and economic state of the company. Therefore, I will use the information coded under financial and nonfinancial and trace each information component to balance sheet, income statement, cash flow statement, and business review.
 FTSE website