Do Institutional Investors Rely on Sell-Side Analysts? Evidence from Cash Flow Forecasts and Target Prices

Existing studies show contradicting results regarding the usefulness of sell-side analysts’ forecasts to institutional investors. While institutional investors are the key customers of analysts’ outputs (Ljungqvist et al., 2007) and they respond to it in a sophisticated manner (Malmendier and Shanthikumar, 2014), institutional investors tend to herd following analysts’ stock recommendations (Brown et al., 2014) and institutional investors’ response to analysts’ target prices does not yield to any excess return in the future (Lin et al., 2016). Therefore, in this thesis, I build on this literature and complement it by examining several aspects of this relationship taking into consideration the heterogeneity in the level of informativeness between different types of institutional investors. More specifically, this thesis provides three pieces of empirical evidence on how institutional investors benefit from forecasts provided by sell-side analysts by answering the following three questions: Do cash flow forecasts contain incremental value to institutional investors? Do foreign institutional investors respond to target price revisions? Lastly, do institutional investors herd when using target prices? The findings of this thesis show that, overall, institutional investors respond to cash flow forecasts and target price revisions. In addition, after splitting institutional investors based on their investment horizon, short-term institutional investors showed a greater response to cash flow forecasts compared with long-term institutional investors. Moreover, the results show that foreign institutional investors do respond to analysts’ target price revisions, a behaviour which contributed positively to their profitability. Finally, the results show that institutional investors do herd following target price revisions. After splitting the institutional investors based on their investment, the herding behaviour of short-term institutional investors positively impacted the future stock prices. Overall, the results of this thesis show that institutional investors benefit from sell-side analysts’ forecasts.