Equity Ownership in IPO Issuers by Brokerage Firms and Analyst Research Coverage

Abstract:     
We examine the relation between brokerage firm research coverage and their equity ownership in IPO issuers due to earlier venture investments. A major concern of investors and regulators is that these combined activities can compromise the accuracy of analyst reports by giving brokerage firms incentives to support the IPOs of issuers in which they are ventures investors. Alternatively, equity ownership could enhance the credibility of affiliated analysts with investors and discourage affiliated analysts from providing booster shots to issuer stock prices. Equity ownership could also align the interests of brokerage firms and IPO issuers by inducing affiliates to provide research coverage, especially by Institutional Investor all star analysts. Our results indicate that offering venture investment and analyst research under one roof benefits both issuers and IPO investors and does not create serious conflicts of interest between affiliated firms and investors. The recommendations of affiliated analysts are less overly optimistic and produce larger abnormal announcement returns, especially for issuers with greater information asymmetry. Our results also yield several implications for the recent NASD and NYSE rules changes regarding equity ownership of IPO firms and affiliated analysts.

Keywords: stock recommendations, sell-side analyst, equity ownership, universal banking, financial institutions

JEL Classifications: G24, G28, G29, G38, G14

Working Paper Series