When Security Analysts Talk Who Listens?

Regulators’ interest in analyst recommendations stems from the belief that small investors are unaware of the conflicts sell-side analysts face and may, as a consequence, be misled into making suboptimal investment decisions. We examine who trades on security analyst stock recommendations by extending prior research to focus on investor-specific responses to revisions. We find that both large and small traders react to recommendations; however, large investors appear to trade more in response to the amount of information contained in the analyst’s recommendation and earnings forecast revision. By contrast, small investors tend to trade more than normal to the occurrence of a report, regardless of its informativeness. We also find that small investors do not fully account for analyst incentives, as captured by type of recommendation (i.e., upgrade versus downgrade or buy versus sell) or analyst affiliation. On average, we observe that small traders are net purchasers following recommendation revisions regardless of the type of the recommendation, while large traders tend to be net sellers following downgrades and sells. These findings are consistent with large investors being more sophisticated processors of information, and provide support for regulators’ concerns that analysts may more easily mislead small investors. JEL classifications: G11; G14; G24; G28; M41