Hypotheses development

5.2.1 Background

The Malaysian stock market is one of the many emerging markets in the world that relies on a foreign investment portfolio, thus competition to attract them to invest as well as to retain them is stiff. In order to attract continuous investment, there should be sufficient information available to the investors about the companies listed on the stock market.

Accordingly, the efforts and measures taken to promote the companies listed on each market are essential. By promoting the companies listed on the Malaysian stock market, there would be more information available to investors that would increase the companies’

visibility and awareness among investors. Indirectly, the promotion of companies listed on Bursa Malaysia would attract more trading in the stock market, resulting towards a more liquid domestic market. As described earlier in Section 3.6 a liquid market is preferred to an illiquid market and deemed essential to attract both domestic and foreign fund to invest and continuously reinvest in the stock market.

We have also mentioned in Section 2.6 about the incentive scheme of financial ana-lysts coverage implemented in the Malaysian stock market with the objective to promote companies. As discussed before, the incentive scheme is taking a different approach from the existing practise in order to increase the activities of financial analysts coverage, and therefore the main concern in the research is to discover whether the incentive scheme is beneficial to investors, the companies, the brokerage companies and other market partic-ipants. Particularly, this study is interested in investigating the effects of the release of analysts’ initial reports of companies that are participating in the incentive scheme.

5.2.2 Research hypothesis

Earlier in Section 4.2 and 4.3 we have described the importance of financial analysts in promoting the company and monitoring the performance of the company they are covering, while in Section 4.7 we have discussed the importance of the financial analysts’

initiation report in attracting the investors’ attention. As the analysts’ initial reports is an important document in initiation of a coverage, the release date of the initiation report is also an important event. We have also described earlier in Section 4.7 that due to its importance, the initiation of financial analysts’ coverage should have a bigger impact than financial analysts’ follow-up or continuing reports.

Consequently, the content of analysts’ initial reports should be more accurate and should have more value than that of continuing recommendations in order to attract the investors’ attention. It is because we have shown earlier in Section 3.5 that theoretically the investors’ profit is proportionate to the amount of private information he got. In other words, if the analysts reports have new content or private information, then the first investor who reacts and takes position from the information would be able to maximise his profit.

We have also shown in Section 3.5 that when there is more than one informed investor, then the informed investors will compete with each other to trade aggressively in order to maximise their profit, resulting in price quickly revealing the new information. It means that if there is new information in the reports, then price would adjust to incorporate new information and abnormal return would be observed around the date of reports.

Eventually, the analysts coverage contributes to prices quickly revealing new information which could be obtained from the analysts reports, and subsequently price would change substantially and immediately which would be accompanied by heavy trading activity.

We have described in Section 3.3 that the prevailing information asymmetry could increase adverse selection costs among investors. Information asymmetry also affects asset prices, cost of capital and valuation of a company. As discussed in Section 4.6, the financial analysts coverage could reduce information asymmetry which would reduce adverse selection among investors. This would eventually reduce the cost and risk of trading and increase the valuation of the company.

We have also mentioned earlier in Section 4.6 that the effects of analysts reports and recommendations could be measured on the day the reports were published as well as surrounding days around the published date. As a result, the financial analysts coverage would have effects on prices and trading activity. Effectively, we expect that the release of analysts report would induce a higher valuation and liquidity in companies covered by financial analysts than the companies that were not covered by the analysts. However, if investors were already aware of or have already anticipated the content of the analysts reports, then neither the analysts reports nor their recommendations have any significant effects on prices and trading activity.

By the same token, we expect that the analysts recommendation to buy would result in an increase in price. On the other hand, the analysts recommendation to sell would result in a price drop. If the analysts recommendations have influence on investors to revise their expectations and beliefs about the distribution of future asset return, then we expect that the analysts recommendations would trigger more trading activities than usual. However, we expect that a favourable recommendation would generate more trading activities than unfavourable recommendation, as we expect more investors would react to a favourable recommendation than an unfavourable one.

Based on the arguments outlined above which are obtained from previous theoretical and empirical studies, we develop the following null hypotheses:

Hypothesis 1. There are no significant differences of stock valuation, stock return, trading volume, liquidity and information asymmetry in the participating companies be-fore and after the release of the financial analysts’ reports.

Hypothesis 2. There are no significant differences of stock valuation, stock return, trading volume, liquidity and information asymmetry between companies that received favourable analysts’ recommendation and companies that received less favourable ana-lysts’ recommendation.

Since the study also compares the performance of the participating companies with a control group matched by the type of industry, the following null hypothesis is going to

be tested:

Hypothesis 3. There are no significant differences of stock valuation, stock return, trading volume, liquidity and information asymmetry between the participating compa-nies and the control group.