Do Analyst Conflicts Matter? Evidence from Stock Recommendations

Abstract

We examine whether conflicts of interest with investment banking and brokerage businesses induce sell-side analysts to issue optimistic stock recommendations and, if so, whether investors are misled by such biases. Using quantitative measures of potential conflicts constructed from a novel data set containing revenue breakdowns of analyst employers, we find that recommendation levels are indeed positively related to conflict magnitudes. The optimistic bias stemming from investment banking conflicts was especially pronounced during the late-1990s stock market bubble. However, evidence from the response of stock prices and trading volumes to upgrades and downgrades suggests that the market recognizes analysts' conflicts and properly discounts analysts' opinions. This pattern persists even during the bubble period. Moreover, the 1-year stock performance following revised recommendations is unrelated to the magnitude of conflicts. Overall, our findings do not support the view that conflicted analysts are able to systematically mislead investors with optimistic stock recommendations. (c) 2008 by The University of Chicago. All rights reserved..

Target Price Accuracy

“…On the other hand, another strand of literature finds quite the reverse concerning conflicts of interest and, thus, exculpates analysts. Iskoz (2003) and Agrawal and Chen (2008), for instance, provided evidence that affiliated analysts do not seem to issue more biased reports than analysts from independent research firms. Cowen, Groysberg, and Healy (2006) even found that analysts employed by banks which fund research through underwriting and trading activities issued less optimistic forecasts and recommendations as opposed to banks which do not perform M&A services at all.…”

Never judge a book by its cover: what security analysts have to say beyond recommendations

“…Bradshaw et al (2003) find that analysts routinely manipulate their investment advice in response to investment banking pressure. A recent study by Agrawal and Chen (2008) documents that the level of recommendations is positively related to the conflicts of interest an analyst faces. However, they find that the market properly discounts the positive bias.…”

Are REIT Investors Overly Optimistic after Equity Offerings?: Evidence from Analyst Forecast Errors

“…There are a number of years for which we do not find any sample REIT IPO activity (i.e., 1982, 2000, 2001, and 2008. We also find that 26 of the sample REITs were listed prior to 1982.…”

“…3 There is a large literature that investigates bias in analyst recommendations (i.e., Dugar and Nathan (1995), Lin and McNichols (1998), Michaely and Womack (1999), and, more recently, Iskoz (2003), Malmendier and Shanthikumar (2007), Agrawal and Chen (2008), and Kadan, Madureira, Wang, and Zach (2009)) have demonstrated that analyst bias is at least partly driven by underwriting relationships. 4 It is important to note that in this paper we are ambiguous on whether REITs under or over perform after IPOs and SEO.…”