Analysts' Risk Discussions and the Use of Valuation Models: A Content Analysis of Sell-Side Equity Analyst Reports

This dissertation consists of three research studies on sell-side equity analysts based on textual analysis of analyst reports from Investext. In the first study, I examine whether analysts' geographic location is associated with their discussions about risk. Using textual analysis of analysts' reports to extract their risk discussions for firms globally, I find that foreign analysts present more risk discussions than local analysts. Foreign analysts' more extensive risk discussions are associated with their unfamiliarity with the underlying firms. Analysts' risk discussions are incrementally informative to investors. The informativeness of risk discussions is similar for foreign analysts and local analysts. The second study examines whether comparability of the underlying firms to their peers affects the informativeness of discounted cash flow (DCF) models and price-to-earnings (PE) models used by analysts. I hypothesize that analysts are more likely to be subject to anchoring and adjustment bias when using PE models compared with using DCF models. The bias is more severe when the underlying firms are not comparable to other firms. Consistent with this argument, I find that market reactions to analysts' investment opinions based on DCF models are stronger than their opinions based on PE models. Furthermore, the incremental effect of DCF models on market reactions to analyst investment opinions is mainly restricted to firms with less comparability. In the third study, I use textual analysis to detect analysts' use of valuation models for a large sample of analyst reports on firms around the world. I classify these models into accrual models and cash flow models. Given the fact that accrual models are the default models used in analyst reports, I examine whether the firm country's institutional factors are associated with analysts' choice of cash flow models. I find that analysts are more likely to use cash flow models to value firms in countries with stronger investor protection, better information environment, and greater economic freedom. The market reactions to target price changes based on cash flow models are stronger, particularly in countries with a stronger institutional environment. The findings suggest that countries with sound institutions facilitate analysts' use of cash flow models.