Effect of Reg FD on Information in Analysts’ Rating Changes

A rich literature examines the effects of analysts’ recommendations on stock prices, and literature is developing on the effect of Regulation Fair Disclosure on the information associated with corporate earnings forecasts and announcements. This study examines the effect of Reg FD on the information content of analysts’ rating changes. Based on recommendations associated with a random sample of S&P 500 Index stocks, the major finding is that investors have been responding to analysts’ recommendations in the same way since Reg FD as they did before implementation of Reg FD. In addition, the results suggest that Reg FD does not require that practitioners change the way they view the analyst recommendation process. The U.S. SEC’s Regulation Fair Disclosure was first drafted in December 1999, was released in August 2000, and became effective on 23 October 2000. Reg FD was designed to eliminate “selective disclosure” that operated between the company and its analysts or institutional investors. Selective disclosure occurs when a company releases material nonpublic information to specific groups at different times. The practitioner media have extensively discussed the effects of Reg FD on the behavior of corporate financial officers and their interactions with stock analysts and on the analyses carried out by the analysts. In addition, a growing number of academic studies have focused on the effect of Reg FD on earnings announcements or analysts’ earnings forecasts. A rich literature also examines the effects of analyst recommendations on stock prices. This study contributes to the literature by examining the effect of Reg FD on the information content of analysts’ changes in recommendations between a preregulation period (1 August 1999 to 31 July 2000) and a postregulation period (1 January 2001 to 31 December 2001). We used a large sample of upgrade and downgrade recommendations for a random sample of 167 S&P 500 Index stocks. We compared stock reactions (price and volume) to upgrades and downgrades in the preregulation period with reactions in the postregulation period. The analyst recommendations fell into 14 action levels, which could be grouped into five categories: 1 = strong buy, 2 = buy, 3 = market outperformance, 4 = hold, and 5 = sell. With respect to downgrades, the overall results in the form of price impact for the announcement day were negative and significant in the pre- and postregulation periods. The change in the effect of Reg FD in the postregulation period, however, varied by action level (but at the action level, samples were small). The overall conclusion is that there has been no Reg FD impact on downgrades. With respect to upgrades, the overall results in the form of price impact for the announcement day were significant in the pre- and postregulation periods, but we found no significant difference between the effect by period. Reg FD does not appear to have affected the impact of upgrades on stock prices. The volume associated with a rating change, as measured by abnormal volume, declined after Reg FD was implemented. The sample of 2,247 observations included 1,329 observations of single actions and 918 observations of multiple recommendations—that is, several actions recommended for the same stock simultaneously on Day 0 or a few days apart within the Day –4 to Day +4 announcement period. Moreover, the initial analyses did not consider the effect of decimalization of the U.S. exchanges, which occurred in the period studied (for the NYSE and Amex, 19 January 2001; for NASDAQ, 9 April 2001). These factors were controlled for in further tests. We used regression analyses to examine the effects of the multiple same-day and overlapping recommendations and decimalization on stock prices in the pre- and postregulation periods. The multiple same-day recommendations were found to be statistically significant control variables and increased the magnitude of the average prediction errors on the announcement day. Downgrades had a much larger impact on abnormal returns than upgrades. The decimalization variables were not significant but did pose a problem in estimating the value of the variable to test for a change in the impact of Reg FD on the value of analysts’ rating changes after the implementation of Reg FD on 23 October 2000. The coefficient for this variable was negative but insignificant. The major finding of this study is that investors continue to respond to analysts’ recommendations in the same way after the implementation of Reg FD as they did before its implementation. Given the lack of a significant change in the impact of recommendation changes on stock prices, the results do not require practitioners to change the way they view the analyst recommendation process.