The Integrity of Financial Analysts: Evidence from Asymmetric Responses to Earnings Surprises

Abstract

This paper investigates the integrity of financial analysts by examining their recommendation responses to large quarterly earnings surprises. Although there is no significant difference in recommendation changes between affiliated and unaffiliated analysts in response to positive earnings surprises, affiliated analysts are more reluctant than unaffiliated analysts to downgrade stock recommendations in response to negative earnings surprises. The evidence implies that conflicts of interest undermine the integrity of financial analysts. We further examine the effects of reputation concern and the Global Research Analyst Settlement as informal and formal mechanisms, on restoring analysts' integrity. The results show that the positive bias in recommendations remains prevalent for affiliated analysts from reputable investment banks and for the post-reform period. Finally, evidence from market reactions suggests that investors fail to notice that analysts' integrity is compromised by conflicts of interest and are misled by affiliated analysts.

Corporate Responsibility Disclosure, Information Environment and Analysts’ Recommendations: Evidence from Malaysia

“…As a robustness test, we chose the first analyst report issued after the issuance of the annual report. We selected the first analyst report because the earliest report reflected analysts' immediate response to the arrival of new information [142]. Accordingly, we measured stock recommendations by three ordered scales: 3 for buy, 2 for hold, and 1 for sell, where a higher score indicates more favorable stock recommendations.…”

Short selling and the independence of business‐related analysts: Evidence from an emerging market

“…Independence is crucial for financial analysts to fulfil their role as a key information intermediary in capital markets. Unfortunately, analysts' independence can be compromised by their incentive to maintain good relationships with the company management (Das et al, 1998), the investment banking business of brokerage firms (Lin & Mcnichols, 1998; Lu et al, 2016; Michaely & Womack, 1999) and the pressure to generate trading commission (Agrawal & Chen, 2008; Firth et al, 2013; Gu et al, 2013). Prior research shows that competition from peer analysts (Hong & Kacperczyk, 2010), implicit monitoring from independent analysts or crowdsourced research (Gu & Xue, 2008; Jame et al, 2022) and reputation and career concerns (Jackson, 2005; Ljungqvist et al, 2007) help to maintain analysts' objectivity.…”