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

2012 NTUICF Conference 1

CFA Certification Programs and Sell-Side Analysts

Qiang KangFlorida International University

Xi LiHong Kong University of Science and Technology

Tie SuUniversity of Miami

“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)

22012 NTUICF Conference

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.

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?

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

That’s it!103,033 as

of December 2012.

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.

Ask me about CFA salaries!

2012 NTUICF Conference 11

• U.S. reported median compensation ranging from $158K to $456K

• Portfolio managers of equities, highest median compensation 5-10 years, $398K10+ years, $500K

• Investment bankers and sell-side research analysts ranked next

• Overall compensation highest in U.S. and U.K.

CFA Charterholder Compensation

The median US household income

in 2011 was $51,413.

The CFA program 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

No other certification covers

ethics.Q: Are CFA

charterholders more ethical?

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 $,$$$,$$$$.

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.

Prior Research

Occupational certification:1. Rottenberg (1980)2. Angrist and Guryan (2004)3. Goldhaber and Brewer (2000)4. Kleiner and Kurdrle (2000)5. Kugler and Sauer (2005)6. Wilensky and Rossiter (1983)7. Wolverton and Epley (1999)

Lawyers, doctors, and teachers…

Prior Research

Analyst performance, behavior, and career outcome:1. Kothari (2001)2. Lee (2001)3. Smith, Craig, and Solomon (2003)4. Chevalier and Ellison (1999)5. Piotroski and Roulstone (2004)6. Hong and Kubik (2003)7. Hong, Kubik, Solomon (2000)8. De Franco and Zhou (2009)9. Emery and Li (2009)10. Jacob, Lys, and Neale (1999)

Hot topic!

They are most closely related to

our paper.

Our Focus

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

What’s new in our paper?

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.

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

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.

Summary Statistics

Table 2.A. CFA and Gender Composition

CFA Non-CFA SumFemale 174 (5.01%) 389 (11.20%) 563 (16.21%)Male 1,085 (31.23%) 1,826 (52.56%) 2,911 (83.79%)Sum 1,259 (36.24%) 2,215 (63.76%) 3,474 (100.00%)

Many charterholders

work as analysts. Many analysts are

charterholders.

Summary Statistics

Table 2.B. Analyst Characteristics

Variable Full Sample Non-CFA CFA

ALPHA (bps) 2.20 2.33 1.93

INFORATIO 0.17 0.17 0.16

ACCURACY 50.13 50.18 50.01

RESIRISK (bps) 12.26 13.00 10.70

BOLDNESS 50.19 50.20 50.19

PCTSELL (%) 4.18 3.91 4.75

OPTIMISM 48.01 47.95 48.16

IISTAR (%) 12.77 12.83 12.64

Don’t be fooled by this statistic!

Statistically significant.

Summary Statistics

Table 2.B. Analyst Characteristics

Variable Full Sample Non-CFA CFA

WSJSTAR (%) 8.28 7.34 10.27

EXPERIENCE 1.62 1.52 1.83

COVERAGE 2.05 2.06 2.03

#REPORT 2.31 2.28 2.38

#COMPANY 2.46 2.40 2.58

BROKERSIZE 3.30 3.36 3.19

CO-SIZE ($B) 0.74 0.73 0.76

N 12,270 8,315 3,955

Performance Improvement

0 1 .t t tDependentVariable a a Year EffectsCFA

Dependent variables:ALPHAINFORATIO

What’s wrong with this simple/naïve

model?

Information Uncertainty

0 1 .t t tDependentVariable a a Year EffectsCFA

Information Uncertainty:COMPANY SIZECOVERAGE

This model is well specified.

0 1 2 3 4

5 6 7 8 9

*t t t t

t t t t t

tDependentVariable a a a a IISTAR a WSJSTARa EXPERIENCE a COVERAGE a NREPORT a NCOMPANY a BROKERSIZEa COMPANY

CFA CFA

InformationU

ZE Year Effects Analyst Effects Brokerag

ncertai

.tffects

Table 3. Analyst Performance

ALPHA INFORATIO

CFA 2.86 0.15(z-stat) (3.70) (3.23)

WSJSTAR -1.10 -0.16(z-stat) (-2.48) (-3.84)

R-square 0.40 0.32

N 12,270 12,270

Key result

Don’t be a star.

Be a CFA charter-holder!

Information Uncertainty: Size

Table 4.1. Analyst Performance

ALPHA INFORATIO

CFA 3.55 0.17(z-stat) (3.96) (3.45)

CFA*co_size -0.95 -0.02

(z-stat) (-2.68) (-1.20)

R-square 0.40 0.32

N 12,270 12,270

CFA charterholders do even better when firms

are small!

Information Uncertainty: Coverage

Table 4.2. Analyst Performance

ALPHA INFORATIO

CFA 8.50 0.41(z-stat) (3.15) (3.09)

CFA*coverage -2.75 -0.12(z-stat) (-2.40) (-2.04)

R-square 0.40 0.32

N 12,270 12,270

No one covers this stock? Ask a

charterholder!

Key result

Don’t be a star. Be a CFA charterholder!

Size Coverage

Before and After CFA

0 1 2 3

4 5 6 .t t t t

t t t t

DependentVariable a a a EXPERIENCE a NREPORTa NCOMPANY a BROKE

YTOCFRSIZE a COMPANYSI

You would think that an analyst’s performance would improve after getting his/her charter, right?

ALPHA INFORATIO

Before CFA 2.17 0.23(z-stat) (2.03) (2.12)

After CFA 1.11 0.07

(z-stat) (1.06) (0.88)

R-square 0.01 0.01

N 415 415

Unsolved Mystery

Significant improvement!

Unsolved Mystery

Risk-Taking and Bias

Dependent variables:RESIRISKPCTSELL

0 1 2 3 4

5 6 7 8

t t t t t

t t t t

DependentVariable a a a IISTAR a WSJSTAR a EXPERIENCEa COVERAGE a NREPORT a NCOMPANY a BROKERSIZEa COMPANYSIZE Year Effects Analyst Effects Brokerage Fi

rmEffects

Risk-Taking and Bias

Table 5

More sell recommendations

More reliable!

Mobility

Ordered Probit model:0: if 95+% to 95-%1: if 95-% to 95-% or 95+% to 95+%2: if no job change3: 95-% to 95+%

Statistical technology!

0 1 1 2 1 3 1

4 1 5 1 6 1

7 1 8 1

t t tt

a a CFA a IISTAR a WSJSTARa ACCURACY a INFORATIO a EXPERIENCE

JobMobilitya NREPORT a NCOMPANYa COMPANYSIZE Year Effects

Mobility

Table 8. Mobility among Brokerage FirmsCFA IIStar WSJStar Alpha Accuracy

0.07 -0.06 -0.01 0.02 0.01

Experience Coverage #REPORT #company Co-Size

-0.07 -0.01 -0.15 0.12 0.01

More likely to move

up!More $,$$

Mobility

Table 6

More likely to move

up!More $,$$

Controlling for Selection Bias

0 1 2 1 3 1 4 1

5 6 1 7 1 8 1

9 1 10 1 11 1 .

t t t t

Selection a a FEMALE a IISTAR a WSJSTAR a EXPERIENCEa COVERAGE a NREPORT a NCOMPANY a BROKERSIZEa COMPANYSIZE a INFORATIO a ACCURACY

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

Controlling for Selection Bias

Table 7Parameter estimates are robust: ALPHA=2.86;

INFORATIO=0.15

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%

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!

We really mean it!The paper is currently

at the JFQA.

Download the full paper.

Thank You!

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

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