How Informative are Analyst Recommendations and Insider Trades? by Jim Hsieh, Lilian Ng, Qinghai Wang

Mixed signals. They happen all the time in and out of finance. Take for instance the starting pitcher saying he can go another inning while wearily dragging himself onto the field, or the spouse who is crying while saying things are fine, or the CEO selling shares while stock analysts write ringing endorsements.

While Hsieh, NG, and Wang may not be able to help you interpret the mixed signals on the field or at home, they do look at this issue with respect to analyst stock recommendations and insider trades. They find that "insider trading is informative when signaling positive information, and analyst recommendations are informative when conveying negative information...."

SSRN-How Informative are Analyst Recommendations and Insider Trades? by Jim Hsieh, Lilian Ng, Qinghai Wang:

In one of the best abstracts I have seen in a long time, the authors succiently summarize their paper:

"This study jointly evaluates the informativeness of insider trades and analyst recommendations. We show that the two activities often generate contradictory signals. Insiders in aggregate buy more shares when their firm's stock is unfavorably recommended or downgraded by analysts than when it is favorably recommended or upgraded. This result is robust to various controls such as varying degrees of analyst coverage, firm size, book-to-market ratios, and stock price momentum. We find that analyst recommendations affect insider trading decisions, but not vice versa. Our further analysis shows that insider trading is informative when signaling positive information, and analyst recommendations are informative when conveying negative information. The overall results imply that corporate insiders and financial analysts do not substitute each other's informational role in the financial market."

Wasn't that a great abstract?

A few points worth mentioning:

* "Using data on insider trading and analyst recommendations from 1994 through 2003, we
show that insider trades and analyst recommendations produce contradictory informational
signals: insiders trade against the recommendations from financial analysts."

* It is surprising that insider trading does not impact analyst recommendations. I am not totally convinced.

And finally the bombshell:

"...analysis shows that insider trades are informative only when insiders are actively buying their company’s stock, and that analyst recommendations hold investment value only when they issue downgrade recommendations on stocks with no insider trading."

So ignore insider sells and analyst buy recommendations.

Definitely worth reading!

Cite:
Hsieh, Jim, Ng, Lilian K. and Wang, Qinghai, "How Informative are Analyst Recommendations and Insider Trades?" (April 12, 2005). AFA 2006 Boston Meetings Paper http://ssrn.com/abstract=687584