Who Follows the Prophets? Analysts' Stock Recommendations and the Trading Response of Large and Small Traders

Abstract

Consistent with the industry practice of linking analyst compensation to their reputation, we find that large traders primarily follow the advice of star analysts and ignore the recommendations of non-star analysts. They buy (sell) stocks for which star analysts revise their recommendations upwards (downwards). Small traders are also privy to analyst advice - they respond quickly to recommendation upgrades by buying the upgraded stocks. However, they do not sell stocks that are downgraded. Small traders, thus, seem unwilling or unable to respond to unfavorable firm-specific news even when the investment implications of the news are reasonably obvious. Small traders are also less discriminating between star and non-star analysts. Our findings not only help understand the clientele of analysts' stock recommendations but also contribute to the literature that focuses on the response of small investors to firm-specific information events.