CFA Certification Programs and Sell-Side Analysts Qiang Kang Florida International University

1. CFA Certification Programs and Sell-Side Analysts Qiang Kang Florida International University Xi Li Hong Kong University of Science and Technology Tie Su University of Miami 2012 NTUICF Conference

2. “Lawyers have to pass the bar, doctors have medical school and even stockbrokers need a license before practicing their crafts. But stock analysts, who can make or break a company’s stock with their research, don’t need any credentials to hang their shingles on Wall Street.” -- Kelleher (2001) 2012 NTUICF Conference

3. The CFA program The Chartered Financial Analyst (CFA) program is an existing voluntary certification program offered by the CFA Institute. Candidates receive the CFA designation after successfully completing three levels of examinations. Its popularity has dramatically increased in the recent years. This paper investigates the degree to which the CFA program benefits the performance, behavior, and career outcomes of sell-side analysts. 2012 NTUICF Conference

4. CFA Quiz As of December 2012, there are _________ CFA charterholders around the world. How many of them are in U.S.? How many of them are in China? 2012 NTUICF Conference

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9. That’s it! 103,033 as of December 2012. The CFA program As of December 2012, there are 103,033 CFA charterholders around the world. In recent years, more than 200,000 CFA candidates from over 150 countries enrolled for the exams. Many financial firms and investment funds require the CFA designation as a de facto condition of employment [Warwick-Ching (2003)]. The popularity of CFA has dramatically increased in the recent years and the CFA designation has been considered as the passport to the finance industry. http://www.newcfa.org/#/professions 2012 NTUICF Conference

10. Ask me about CFA salaries! The CFA program • Three levels of CFA exams, offered annually in June (L1 is offered twice a year, June and December). • Six-hour exams, multiple choice questions for L1 and L2, combination of multiple choice questions and essay questions in L3. • CFA Institute recommends a minimum of 250 hours for each exam (i.e. 10-15 hours/week over 18 weeks) • Around 1,500 “Learning Outcome Statements” (LOS) in the self-study program. • Registration and examination fees total to over US$2,500. 2012 NTUICF Conference

11. CFA Charterholder Compensation • U.S. reported median compensation ranging from $158K to $456K   • Portfolio managers of equities, highest median compensation • 5-10 years, $398K • 10+ years, $500K • Investment bankers and sell-side research analysts ranked next   • Overall compensation highest in U.S. and U.K. The median US household income in 2011 was $51,413. 2012 NTUICF Conference

12. The CFA program No other certification covers ethics. Q: Are CFA charterholders more ethical? • Ethics & Professional Standards • Quantitative Methods • Economics • Financial Reporting Analysis • Corporate Finance • Equity Analysis • Fixed Income Investments • Derivative Instruments • Portfolio Management • Alternative Investments 25% of FRA! Learn accounting well! 2012 NTUICF Conference

13. Buy-side vs. Sell-side Analysts • Buy-side analysts working for money managers provide research for in-house use by money managers. An analyst employed by an entity, such as a mutual fund, that invests on its own accounts. • Sell-side analysts working for brokerage firms provide research for the firms’ clients. An analyst employed by a brokerage firm or another firm that manages client accounts. Unlike that of the buy-side analysts employed by mutual funds, research produced by sell-side analysts is usually available to the public. Buy-side makes more $,$$$,$$$$. 2012 NTUICF Conference

14. Buy-side vs. Sell-side Analysts • A sell-side analyst's focus when analyzing possible investments is to see whether the investment should be recommended to the firm's clients, while a buy-side analyst would only be interested in analyzing whether the investment is suitable for the firm's investment strategy and portfolio. Thus, sell-side analysts structure their research such that it is usable for a wider audience than buy-side research. Buy-side analysts often source research from sell-side analysts, and then use this information as a base for buy-side analysts’ own research. 2012 NTUICF Conference

15. Prior Research Lawyers, doctors, and teachers… Occupational certification: • Rottenberg (1980) • Angrist and Guryan (2004) • Goldhaber and Brewer (2000) • Kleiner and Kurdrle (2000) • Kugler and Sauer (2005) • Wilensky and Rossiter (1983) • Wolverton and Epley (1999) 2012 NTUICF Conference

16. Hot topic! Prior Research Analyst performance, behavior, and career outcome: • Kothari (2001) • Lee (2001) • Smith, Craig, and Solomon (2003) • Chevalier and Ellison (1999) • Piotroski and Roulstone (2004) • Hong and Kubik (2003) • Hong, Kubik, Solomon (2000) • De Franco and Zhou (2009) • Emery and Li (2009) • Jacob, Lys, and Neale (1999) They are most closely related to our paper. 2012 NTUICF Conference

17. Our Focus What’s new in our paper? • Completion of the CFA designation. • Does the program benefit analyst performance and behavior? • Are the resources spend on the program justified? • Is ethics training in the program effective? • Analyst Behavior • Performance measures: alpha and information ratio. • Risk-taking: recommendations and forecasts • Bias: percent sell and optimism 2012 NTUICF Conference

18. Data • Institutional Brokers Estimate System (I/B/E/S) and CRSP • Analyst name, brokerage affiliation, earnings forecasts, stock recommendations, affiliation changes. • Earnings forecast database starts in 1983, and its stock recommendation database starts in October 1993. I/B/E/S provides standardized recommendations, with integer ratings from 1 through 5 corresponding to “strong buy,” “buy,” “hold,” “underperform,” and “sell,” respectively. • Analysts with only “hold” recommendations are excluded. 2012 NTUICF Conference

19. Data • CFA Institute Membership Directory • Lexis-Nexis and ProQuest • Matching I/B/E/S analyst names with the CFAI membership directory to identify when the analyst acquires the designation. • Determine the gender of each analyst. • Final sample: 12,270 observations of 3,474 analysts of which 1,259 analysts, or about 36%, are CFA charterholders. Hard work! Time period: 1994-2000 2012 NTUICF Conference

20. Variable Definitions • CFA: Dummy variable • ALPHA: The intercept of the Carhart (1997) model regression in basis points. • INFORATIO: t-statistic for the intercept of the Carhart (1997) model regression. • ACCURACY: Hong et al.’s (2000) measure of relative earnings forecast accuracy. • RESIRISK: Residual return standard deviation of the Carhart (1997) model regression in basis points. • BOLDNESS: Hong et al.’s (2000) measure of boldness in earnings forecasts. • PCTSELL: Percentage of “sells” and “underperforms” among the analyst’s recommendations. • OPTIMISM: Hong and Kubik’s (2003) measure of relative earnings forecast optimism on a one-year basis. • EXPERIENCE: Number of years that an analyst has been submitting reports to I/B/E/S. • COVERAGE: Logarithm of the average number of analysts that cover the same companies that an analyst covers at the end of the prior calendar year. Commonly used variables in current literature. 2012 NTUICF Conference

21. Summary Statistics Table 2.A. CFA and Gender Composition Many charterholders work as analysts. Many analysts are charterholders. 2012 NTUICF Conference

22. Summary Statistics Don’t be fooled by this statistic! Table 2.B. Analyst Characteristics Statistically significant. 2012 NTUICF Conference

23. Summary Statistics Table 2.B. Analyst Characteristics 2012 NTUICF Conference

24. Performance Improvement What’s wrong with this simple/naïve model? • Dependent variables: • ALPHA • INFORATIO 2012 NTUICF Conference

25. Information Uncertainty • Dependent variables: • ALPHA • INFORATIO • Information Uncertainty: • COMPANY SIZE • COVERAGE This model is well specified. 2012 NTUICF Conference

26. Performance Improvement Key result Table 3. Analyst Performance Don’t be a star. Be a CFA charter-holder! 2012 NTUICF Conference

27. Information Uncertainty: Size CFA charterholders do even better when firms are small! Table 4.1. Analyst Performance 2012 NTUICF Conference

28. Information Uncertainty: Coverage No one covers this stock? Ask a charterholder! Table 4.2. Analyst Performance 2012 NTUICF Conference

29. Performance Improvement Key result Coverage Size Table 3. Analyst Performance Don’t be a star. Be a CFA charterholder! 2012 NTUICF Conference

30. Before and After CFA You would think that an analyst’s performance would improve after getting his/her charter, right? • Dependent variables: • ALPHA • INFORATIO 2012 NTUICF Conference

31. Before and After CFA Significant improvement! Table 4. Analyst Performance Unsolved Mystery 2012 NTUICF Conference

32. Before and After CFA Unsolved Mystery Table 4. Analyst Performance Significant improvement! 2012 NTUICF Conference

33. Risk-Taking and Bias • Dependent variables: • RESIRISK • PCTSELL 2012 NTUICF Conference

34. Risk-Taking and Bias Table 5 More sell recommendations More reliable! 2012 NTUICF Conference

35. Mobility Statistical technology! • Ordered Probit model: • 0: if 95+% to 95-% • 1: if 95-% to 95-% or 95+% to 95+% • 2: if no job change • 3: 95-% to 95+% 2012 NTUICF Conference

36. Mobility Table 8. Mobility among Brokerage Firms More likely to move up! More $,$$$,$$$ 2012 NTUICF Conference

37. Mobility Table 6 More likely to move up! More $,$$$,$$$ 2012 NTUICF Conference

38. Controlling for Selection Bias The hazard ratio LAMBDA is estimated from the following first-step regression in the Heckman’s (1979) two-step approach to deal with the endogenous selection bias: Robustness check 2012 NTUICF Conference

39. Controlling for Selection Bias Parameter estimates are robust: ALPHA=2.86; INFORATIO=0.15 Table 7 2012 NTUICF Conference

40. Conclusion Using a comprehensive sample of earnings forecasts and investment recommendations over the 1994 to 2000 period, we find that the CFA program has a significantly positive impact on analyst recommendation performance. The positive impact is also economically meaningful: it is equivalent to an annualized excess return of 7.47%, i.e., 7.47% above the risk-adjusted rate of return on comparable investments. We find that the CFA program reduces risk-taking and bias in recommendations. This is huge!! Consider 10% vs. 17% 2012 NTUICF Conference

41. Comments and Suggestions? • You may download this paper at http://moya.bus.miami.edu/~tsu/. • You may request the paper via email: Tie Su: tie@miami.edu • We welcome your comments and suggestions! Download the full paper. We really mean it! The paper is currently at the JFQA. 2012 NTUICF Conference

42. Thank You! 2012 NTUICF Conference