Research Summary
Research Summary
The Role of Financial and Information Intermediaries in the Capital Markets
Description
Hutton's research investigates the role of financial analysts and short sellers in the pricing of equity securities. Recently, Hutton examines (with Patricia Dechow and Richard Sloan) the role of sell-side analysts' earnings forecasts in the pricing of common equity offerings. Overall the evidence suggests that analysts compromise their role as investment advisors to generate larger underwriting fees for their employers, the investment banks acting as lead managers of the underwritings. In related work (with Patricia Dechow and Richard Sloan), Hutton documents that valuation models employing analysts' earnings forecasts are the best at predicting and explaining contemporaneous stock returns. However, models that assume that competitive forces cause ROEs to decay to firms' costs of equity capital over relatively short periods of time are found to be the most useful at predicting future stock returns. Analyst valuation models are best at predicting current stock returns because analysts' earnings forecasts (including the bias in these forecasts) are initially incorporated in stock prices. The decaying ROE valuation models are best at predicting future stock returns because these models identify the errors in analysts' earnings forecasts that are eventually reflected in stock prices. Hutton also examines (with Patricia Dechow, Lisa Meulbroek, and Richard Sloan) the role of short sellers in the capital markets and finds systematic evidence that short sellers exploit the predictable returns generated from relative-value investment strategies. In particular, short sellers take large positions in securities with low fundamental-to-market values (e.g., low E/P or low B/M) and are able to identify within these sets of securities those that will experience a decline in market value (rather than an increase in fundamental value). Overall, the evidence suggests that the U.S. capital markets are characterized by limited mispricing that is actively arbitraged by sophisticated investors, such as short sellers.