Simona Mola, assistant professor of finance at Arizona State University and co-author of the study, says the team came up with two hypotheses. The first — limited attention — argued that investors who can invest in only a limited number of stocks use analysts’ reports as a source of information. When an analyst drops a stock, it falls off investors’ radar screens. Here, lost coverage is a cause of delisting.
To test the hypothesis, researchers identified a sub-sample of the 163 top performers from the 2,753 firms. They matched the sub-sample against a control group and found that in the year following loss of coverage, there was no difference in performance between the sub-sample and the control group, although the sub-sample still had a higher probability of getting delisted.
That left the academics with another hypothesis — superior information. This suggests that analysts have data that allows them to predict more accurately than investors which companies have a higher probability of getting delisted, and drop coverage in anticipation.
There are two other reasons for analysts to stop following a company. The first is poor performance. Giampaolo Trasi, vice chairman of the European Federation of Financial Analysts’ Societies, says, “Systematic disappointment in meeting earnings targets often implies that the company is not paying enough attention to investors’ needs.” Three consecutive quarters of disappointing earnings can be enough to get dropped. The second reason is monetary, and more relevant to most small- and mid-cap CFOs. If the liquidity of a stock is so low that there is little chance of earning brokerage or underwriting fees from it, analysts are less likely to cover it. This is compounded by the separation of analysts and brokers in investment banks. As a separate function, analysts are a more expensive overhead, which makes them less likely to cover low-return stocks.
Two things may help companies get information about themselves out into the market despite low liquidity. The first is an increase in company-commissioned research. “Because smaller companies become frustrated at the lack of research, they have had to go out and buy [it] from independent research agencies,” says John Pierce, CEO of Quoted Companies Alliance, which represents small- and mid-cap listed firms in the UK.
“We encourage our members to do this because at least it’s additional information in the market about that company. While some criticise it as not being truly independent, if it’s produced by a house with its own reputation to guard, the information should be fairly objective.” Not only that, new regulations across the European Union require such reports be clearly labelled as sponsored.
The second trend has been triggered by the slowdown of the bull market. “The advisory community has been focused on primary issues rather than looking after existing clients,” says Grant Thornton’s Secrett. “It’s more interesting to take 3% to 6% of an IPO than drum up business for existing issuers. But that party [for brokers] has come to an end. There’s been a refocus on managing the secondary market.”