An Analysis of Stock Recommendations

Abstract

We study the information content of stock reports when investors are uncertain about a Þnancial analyst's incentives. Incentives may be aligned, in which case the analyst wishes to credibly convey his information, or incentives may be misaligned. We Þnd that: (a) Any investor uncertainty about incentives makes full revelation of information impossible. (b) Categorical ranking systems, such as those commonly used by brokerages, arise endogenously as equilibria. (c) Under certain conditions, analysts with aligned incentives can credibly convey unfavorable information, but can never credibly convey favorable information. (d) Policies that improve transparency of analyst incentives might reduce the information content of stock reports. Finally, we examine testable implications of the model compared to empirical analyses of stock recommendations.JEL #s: G24, D82

Credulity, lies, and costly talk

“…It is worth comparing our findings with those obtained by Morgan and Stocken [21] in a model of cheap talk where the sender has private information not only about the state (with bounded support, as in CS) but also about his bias, which can be either a positive, state-independent constant or zero. 26…”

“…If m0 < m * (x), existence cannot be guaranteed without further assumptions, and, moreover, the equilibrium would be decreasing, which we find somewhat implausible when m * is increasing. 21 There are differences beyond just the state space, however. For example, his single-crossing condition inx and m is not satisfied in our setting.…”

“…21 By studying the inverse differential equation of (DE), we first show that there exists a unique increasing local solution to (DE) under the initial condition µ(x) = m * (x). 22 We then prove that under condition (C.2), this local solution can be uniquely extended to the whole domain X = [x, ∞).…”

Revisiting games of incomplete information with analogy-based expectations

“…26 This follows by looking at the best-response of the sender and noting that there is a one to one correspondence between the message sent and the choice of action by the receiver. 27 Ex ante biased equilibrium actions are also obtained by Morgan and Stocken (2003) A simple corollary is that when the receiver uses the coarsest analogy partition (n = 1), 28 the unique ABEE is pooling: the receiver chooses action σ R (m) = E(t) for all m.…”

Non-Exclusive Financial Advice

“…But, in contrast with earlier models, we posit that money transfers between investors and their advisors are not feasible. We share this approach both with the recent bulk of work on optimal delegation pioneered by Holmstrom (1984) -see, e.g., Alonso and Matusheck (2008), Dessein (2002), Martimort and Semenov (2006), Melumad and Shibano (1996), for abstract delegation settings, and Morgan and Stocken (2003), among others, for an application to stock recommendation. Our novel contribution to both these literatures is the non-exclusivity aspect.…”