Analysts and Information Gaps: Lessons from the UAL Buyout

In addition to earnings forecasts and stock recommendations, analysts provide potentially useful information to investors in the form of written commentary and analysis. But how such fundamental research affects stock prices has been little studied. I investigate the role analysts' research played in the 1994 restructuring of UAL Corporation (parent of United Air Lines), in which employees acquired 55 percent of UAL stock in exchange for $4.9 billion in wage/benefit concessions. Focusing on the critical first two years of the buyout, my analysis suggests that analysts and investors, on average, initially gave the company little credit for the concessions. The transaction was controversial and complicated. Most analysts were negative or indifferent in their assessment of the deal. Some analysts also misinterpreted key terms of the deal. UAL managers responded by reporting an unconventional earnings measure that highlighted the financial concessions. UAL's stock price relative to the market and industry eventually doubled, but analysts' opinions of the deal did not change. Much academic research has found that sell-side analysts' earnings forecasts and stock recommendations provide information that is useful to investors for valuing corporate securities. Another potentially important source of information for investors is analysts' written commentary and analysis, but how such fundamental research affects stock prices has been little studied. Evaluating the quality and impact of this analysis is clearly difficult if traditional large-sample analysis is the method.I report an investigation into the role analyst research played in the 1994 restructuring of UAL Corporation (parent of United Air Lines), in which employees acquired 55 percent of UAL stock and certain control rights in exchange for $4.9 billion in wage/benefit concessions. My analysis drew on a unique database that included all sell-side analyst reports on UAL, internal company documents, corporate press releases, and interviews with key participants in the case. The UAL buyout was an interesting research site because the restructuring had no precedent and was extremely complicated. Therefore, information gaps were likely to be large and the opportunity existed for analysts to play an especially valuable role as information intermediaries between the company and investors. In addition, the success of the restructuring was highly dependent on the company's future stock price performance because many employees were initially concerned that they had paid too high a price for their stock.Focusing on the critical first two years of the buyout, my analysis suggests that analysts and investors initially gave the company little credit for the concessions. Most analysts were negative or indifferent in their assessment of the deal, and some also misinterpreted key deal terms or made incorrect, potentially misleading inferences about the buyout.For at least the first year of the deal, UAL's stock price performance was unexceptional. One reason may be that the managers were limited in what they could say publicly to address the market's concerns about the company's future; if they emphasized the size of the concessions, they risked antagonizing or alienating employees. In an effort to change investors' perceptions of the buyout, UAL managers devised a new method for reporting earnings (“fully distributed earnings”) that excluded a large noncash charge for employees' stock required under U.S. generally accepted accounting principles (GAAP). And eventually, although analyst opinion of the deal did not change, UAL's stock price relative to the market and industry doubled.The study has a number of important implications for practitioners and researchers. First, the written analyses and commentary that accompany analyst forecasts of earnings and stock prices provide potentially important information. The research may contain opinions about the company's future performance beyond the period covered by the analyst's financial forecasts. Investors may also take the quality of the research into account when weighing competing earnings forecasts. Studies of consensus analyst earnings forecasts and analysts' ability to forecast earnings do not capture the additional information that may be contained in analysts' fundamental research.A second contribution of the study is to broaden understanding of which companies benefit most (or least) from analyst coverage. The results suggest that the value of analyst coverage may be more limited when companies undergo complicated corporate transactions than in simpler situations.Finally, the study highlights some of the problems that managers may encounter when they try to improve their companies' valuations. The experience of UAL with introducing fully distributed earnings may be applicable to Internet companies that are attempting, to the concern of regulators, to use earnings measures that exclude GAAP-mandated charges for goodwill or marketing expenses. UAL's experience suggests that changing investor perceptions through such accounting innovations is difficult.