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Analysts, Incentives, and Exaggeration

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  • Timothy Shields

Abstract

Sell-side analysts are compensated, at least in part, by brokerage commissions. These commissions create an incentive to bias forecasts to generate trade. Thus, analysts have clear economic incentives to deceive and traders have economic incentives to detect deception. Prior analytical theories of information transmission games starkly predict that there will always be some deception (with trade) at best and uninformative messages (and no trade) at worst when the sender's and receiver's incentives are not aligned. Prior experimental evidence of information transmission games show senders do elect to deceive, although they send messages more informative than theory predicts. Likewise, receivers rely more upon messages than theory predicts. Can behavior that deviates from prediction be explained by normative social behavior, such as trust and honesty? Alternatively, are subjects boundedly rational, failing to sufficiently consider other players' incentives when predicting their decisions? To answer these questions, I design and conduct an experiment to investigate whether forecasting and trading behaviors are best explained by analytical theory, limited strategic sophistication, or social norms. The experimental results confirm a majority of subjects adopt dishonest forecasting strategies, but at the same time, a majority of subjects adopts trusting trading strategies. Additionally, subjects do not appear to revise trading behavior despite evidence of deceptive forecasts. The results suggest subjects' behavior within the setting is better explained by limited strategic sophistication than by social normative behavior or sequential rationality. Les analystes du « côté vendeur » sont rémunérés, du moins en partie, au moyen de commissions de courtage. Ces commissions représentent une incitation à fausser les prévisions dans le but d'accroître les activités du marché. Ainsi, les analystes font l'objet de stimulants économiques clairs qui les portent à décevoir, tandis que les négociateurs ont des stimulants économiques qui les incitent à détecter la déception. Les théories analytiques avancées antérieurement à partir des jeux de transmission de l'information prédisent, de façon catégorique, qu'il existera toujours une certaine déception (avec transaction) dans le meilleur des cas et des messages dénudés de renseignements (et sans transaction) dans le pire des cas, à moins que les stimulants de l'émetteur et du récepteur ne concordent. La preuve expérimentale qui a été faite dans le passé par les jeux de transmission de l'information a démontré que les émetteurs choisissent effectivement de décevoir, même si leurs messages sont plus informatifs que la théorie laisse entendre. De la même façon, les récepteurs comptent davantage sur les messages que ce qui est proposé par la théorie. Le comportement qui s'écarte des prédictions peut-il s'expliquer par un comportement social normatif, en l'occurrence la confiance et l'honnêteté? Par ailleurs, les sujets font-ils preuve de rationalité limitée et négligent-ils de considérer suffisamment les stimulants des autres joueurs au moment de prédire leurs décisions? Dans le but de répondre à ces questions, je mets au point, puis je conduis une expérience visant à observer les comportements liés aux prévisions et à la négociation et à établir si ces comportements s'expliquent mieux par la théorie analytique, la sophistication stratégique limitée ou les normes sociales. Les résultats de l'expérience confirment que, d'une part, une majorité de sujets adoptent des stratégies prévisionnelles malhonnêtes et, d'autre part, une majorité de sujets adoptent des stratégies commerciales fondées sur la confiance. De plus, les sujets ne semblent pas revoir leur comportement face au marché, malgré l'évidence de prévisions décevantes. Les résultats portent à croire qu'on peut mieux expliquer le comportement des sujets, dans un contexte donné, par la sophistication stratégique limitée que par le comportement social normatif ou la rationalité séquentielle.

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Bibliographic Info

Paper provided by CIRANO in its series CIRANO Working Papers with number 2008s-11.

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Date of creation: 01 Apr 2008
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Handle: RePEc:cir:cirwor:2008s-11

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Keywords: analyst forecast; levels of sophistication; social norm; bounded rationality; trust; honesty ; prédictions des analystes; niveau de sophistication; norme sociale; rationnalité limitée; confiance; honnêteté;

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  1. Broseta, Bruno & Costa-Gomes, Miguel & Crawford, Vincent P., 2000. "Cognition and Behavior in Normal-Form Games: An Experimental Study," University of California at San Diego, Economics Working Paper Series qt0fp8278k, Department of Economics, UC San Diego.
  2. Crawford, Vincent P & Sobel, Joel, 1982. "Strategic Information Transmission," Econometrica, Econometric Society, vol. 50(6), pages 1431-51, November.
  3. Brennan, Michael J, 2004. "How Did It Happen?," University of California at Los Angeles, Anderson Graduate School of Management qt1047x6kv, Anderson Graduate School of Management, UCLA.
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  7. Miguel Costa-Gomes & Vincent P. Crawford, 2004. "Cognition And Behavior In Two-Person Guessing Games: An Experimental Study," Levine's Bibliography 122247000000000143, UCLA Department of Economics.
  8. Michael J. Brennan, 2004. "How Did It Happen?," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 33(1), pages 3-22, 02.
  9. Michaely, Roni & Womack, Kent L, 1999. "Conflict of Interest and the Credibility of Underwriter Analyst Recommendations," Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 653-86.
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