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Investment Banking and Analyst Objectivity: Evidence from Forecasts and Recommendations of Analysts Affiliated with M&A Advisors

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  • Kolasinski, Adam
  • Kothari, S.P.
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    Abstract

    Previous research finds some evidence that analysts affiliated with equity underwriters issue more optimistic earnings growth forecasts and optimistic recommendations of client stock than unaffiliated analysts. Unfortunately, these studies are unable to discriminate between three competing hypotheses for the apparent optimism. Under the bribery hypothesis, underwriting clients, with the promise of underwriting fees, coax analysts to compromise their objectivity. The execution-related conflict of hypothesis postulates that the investment banks employing analysts who are more bullish on a particular stock are better able to execute the deal, and so the banks pressure their analysts to be bullish in order to enhance their execution ability. Finally, the selection bias hypothesis postulates that analysts are objective, but because of the enhanced execution ability, banks with more optimistic analysts are more likely to get selected as underwriters. We test these hypotheses in a previously unexplored setting, namely M&A activities. Depending on whether an analyst is affiliated with the target or the acquirer and whether the analyst report is about the target or the acquirer, the hypotheses predict analyst optimism in some cases and pessimism in other. Therefore, examining the issue of analyst bias in the M&A context allows us to shed some light on alternative explanations for the impact of analyst affiliation on the properties of analyst forecasts and recommendations.

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    File URL: http://hdl.handle.net/1721.1/5069
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    Bibliographic Info

    Paper provided by Massachusetts Institute of Technology (MIT), Sloan School of Management in its series Working papers with number 4467-04.

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    Date of creation: 28 May 2004
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    Handle: RePEc:mit:sloanp:5069

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    Postal: MASSACHUSETTS INSTITUTE OF TECHNOLOGY (MIT), SLOAN SCHOOL OF MANAGEMENT, 50 MEMORIAL DRIVE CAMBRIDGE MASSACHUSETTS 02142 USA

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    Keywords: Corporate Finance; Investment Banking; Analysts; Conlict of Interest;

    References

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    1. Scharfstein, David S & Stein, Jeremy C, 1990. "Herd Behavior and Investment," American Economic Review, American Economic Association, vol. 80(3), pages 465-79, June.
    2. 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.
    3. Welch, Ivo, 2000. "Herding among security analysts," Journal of Financial Economics, Elsevier, vol. 58(3), pages 369-396, December.
    4. Lin, Hsiou-wei & McNichols, Maureen F., 1998. "Underwriting relationships, analysts' earnings forecasts and investment recommendations," Journal of Accounting and Economics, Elsevier, vol. 25(1), pages 101-127, February.
    5. Trueman, Brett, 1994. "Analyst Forecasts and Herding Behavior," Review of Financial Studies, Society for Financial Studies, vol. 7(1), pages 97-124.
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    Cited by:
    1. Cowen, Amanda & Groysberg, Boris & Healy, Paul, 2006. "Which types of analyst firms are more optimistic?," Journal of Accounting and Economics, Elsevier, vol. 41(1-2), pages 119-146, April.
    2. Ljungqvist, Alexander & Marston, Felicia & Starks, Laura T. & Wei, Kelsey D. & Yan, Hong, 2007. "Conflicts of interest in sell-side research and the moderating role of institutional investors," Journal of Financial Economics, Elsevier, vol. 85(2), pages 420-456, August.

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