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Do Analyst Conflicts Matter? Evidence from Stock Recommendations

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  • Anup Agrawal
  • Mark A. Chen
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    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..

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    Bibliographic Info

    Article provided by University of Chicago Press in its journal The Journal of Law and Economics.

    Volume (Year): 51 (2008)
    Issue (Month): 3 (08)
    Pages: 503-537

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    Handle: RePEc:ucp:jlawec:v:51:y:2008:i:3:p:503-537

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    Web page: http://www.journals.uchicago.edu/JLE/

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    Cited by:
    1. Song, Kyojik “Roy” & Mantecon, Tomas & Altintig, Z. Ayca, 2012. "Chaebol-affiliated analysts: Conflicts of interest and market responses," Journal of Banking & Finance, Elsevier, vol. 36(2), pages 584-596.
    2. Xu, Nianhang & Jiang, Xuanyu & Chan, Kam C. & Yi, Zhihong, 2013. "Analyst coverage, optimism, and stock price crash risk: Evidence from China," Pacific-Basin Finance Journal, Elsevier, vol. 25(C), pages 217-239.
    3. Fecht, Falko & Hackethal, Andreas & Karabulut, Yigitcan, 2013. "Is proprietary trading detrimental to retail investors?," Discussion Papers 42/2013, Deutsche Bundesbank, Research Centre.
    4. Martinez, Jose Vicente, 2011. "Information misweighting and the cross-section of stock recommendations," Journal of Financial Markets, Elsevier, vol. 14(4), pages 515-539, November.
    5. Christopher Koch & Ola Nilsson & Katarina Eriksson, 2014. "Does shareholder protection affect the performance of analysts as a gatekeeper?," Journal of Management and Governance, Springer, vol. 18(2), pages 315-345, May.
    6. Sette, Enrico, 2011. "Competition and optimistic advice of financial analysts: Evidence from IPOs," Journal of Financial Intermediation, Elsevier, vol. 20(3), pages 441-457, July.
    7. Kedia, Simi & Zhou, Xing, 2014. "Informed trading around acquisitions: Evidence from corporate bonds," Journal of Financial Markets, Elsevier, vol. 18(C), pages 182-205.
    8. Murphy, Kevin J. & Sandino, Tatiana, 2010. "Executive pay and "independent" compensation consultants," Journal of Accounting and Economics, Elsevier, vol. 49(3), pages 247-262, April.
    9. Franck, Alexander & Kerl, Alexander, 2013. "Analyst forecasts and European mutual fund trading," Journal of Banking & Finance, Elsevier, vol. 37(8), pages 2677-2692.
    10. Beyer, Anne & Cohen, Daniel A. & Lys, Thomas Z. & Walther, Beverly R., 2010. "The financial reporting environment: Review of the recent literature," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 296-343, December.
    11. Alexander G. Kerl, 2011. "Target Price Accuracy," BuR - Business Research, German Academic Association for Business Research, vol. 4(1), pages 74-96, March.
    12. Niehaus, Greg & Zhang, Donghang, 2010. "The impact of sell-side analyst research coverage on an affiliated broker's market share of trading volume," Journal of Banking & Finance, Elsevier, vol. 34(4), pages 776-787, April.

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