Conflicts of Interest in Sell-side Research and the Moderating Role of Institutional Investors

Abstract:     
Sell-side analysts face pressure to provide favorable opinions on their employers' investment banking clients and to boost brokerage business, yet institutional investors value unbiased research. Because of their dependence on institutional investors for performance ratings and trading commissions, we argue that analysts are less likely to succumb to pressure in stocks that are highly visible to their institutional investor constituency. Given the apparent severity of analyst conflicts of interest in the late 1990s, we examine a comprehensive sample of analyst recommendations over the 1994-2000 period. We find that analysts' recommendations relative to consensus are positively associated with investment banking relationships and brokerage pressure, but negatively associated with the presence of institutional investors in the firm being followed. This is especially true when there are more institutions holding larger blocks in the firm, and for firms whose institutional holdings are concentrated in the hands of the largest institutional investors. The presence of institutional investors is also associated with more accurate earnings forecasts and more timely re-ratings following severe share price falls.

Keywords: Analyst recommendations, Analyst forecast accuracy, Investment banking, Conflicts of Interest, Institutional investors, Banking Relationships

JEL Classifications: G20, G21, G23, G24

Working Paper Series