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Competition and Opportunistic Advice of Financial Analysts: Theory and Evidence

  • Enrico Sette

    ()

This work investigates both theoretically and empirically how the behaviour of financial analysts is affected by competition, measured as the strength of coverage of a stock from other analysts. The interaction among analysts and investors is modelled as a dynamic cheap talk game. The theoretical model shows that analysts having a conflict of interest with investors, report information truthfully with higher probability if other, “neutral”, analysts report information on the same stock. This empirical prediction is tested on data about recommendations on IPOs. The main result is that analysts working for the lead underwriter of the IPO (“insiders”) are more optimistic when there are no other analysts (not working for the lead underwriter, “outsiders”) covering the stock. The data also show that insiders do not seem to use the information contained in outsiders recommendations. Finally, outsiders are not influenced by recommendations previously issued by insiders. These results also allow to discriminate between competing hypothesis brought forward to explain insider’s overoptimism. The empirical evidence suggests that insider analysts overoptimism is induced by incentives rather than by a “psychological bias”.Keywords: Competition, Financial Analysts, IPOs, Recommendations.JEL Classi�cation codes: D40, D82, G24, L15

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Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp592.

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Date of creation: Jun 2007
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Handle: RePEc:fmg:fmgdps:dp592
Contact details of provider: Web page: http://www.lse.ac.uk/fmg/

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  1. Andrew R. Jackson, 2005. "Trade Generation, Reputation, and Sell-Side Analysts," Journal of Finance, American Finance Association, vol. 60(2), pages 673-717, 04.
  2. Benabou, R. & Laroque, G., 1988. "Using Privileged Information To Manipulate Markets: Insiders, Gurus And Credibility," Papers 19, Princeton, Woodrow Wilson School - Discussion Paper.
  3. Harrison Hong & Jeffrey D. Kubik, 2003. "Analyzing the Analysts: Career Concerns and Biased Earnings Forecasts," Journal of Finance, American Finance Association, vol. 58(1), pages 313-351, 02.
  4. Stephen Morris, 1999. "Political Correctness," Cowles Foundation Discussion Papers 1242, Cowles Foundation for Research in Economics, Yale University.
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