Do Analyst Conflicts Matter? Evidence from Stock Recommendations

Abstract

We examine whether conflicts of interest with investment banking and brokerage 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 revenue breakdowns of analyst employers, we find that the level of analysts' stock recommendations is indeed positively related to the magnitude of the conflicts they face. The optimistic bias stemming from investment banking conflict 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 analyst conflicts and properly discounts analyst opinions. This pattern persists even during the bubble period, contrary to popular belief that investors threw caution to the wind during the bubble. Moreover, the one-year performance of 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.

Keywords: Stock analysts, Security analysts, Analyst conflicts, Corporate governance, Stock recommendations, Wall Street research, Brokerage research, Conflicts of interest

JEL Classification: G24, G28, G34, G38, K22, M41