Changes in Analysts’ Stock Recommendations Following Regulatory Action Against Their Brokerage

Abstract

Despite the importance of sell-side analysts in the capital markets, we know little about the effectiveness of routine monitoring of the sell-side industry. We examine the attributes of sell-side research issued by analysts before and after their brokerage is subject to regulatory sanctions. We find that after a regulatory action, analysts at sanctioned brokerages lower their stock recommendations, both in absolute terms and relative to the recommendations of other analysts following the same firms. Following a regulatory action, analysts at sanctioned brokerages are also more likely than analysts at other brokerages to downgrade a company’s stock after the receipt of unfavorable information about the firm. Importantly, we document that analysts at non-sanctioned brokerages also reduce the optimism in their stock recommendations when a peer analyst’s brokerage is sanctioned, consistent with regulatory spillovers as a result of routine regulatory monitoring. Our study provides empirical evidence that regulatory action against sell-side brokerages is associated with a reduction in sell-side analysts’ positive bias at both sanctioned and non-sanctioned brokerages.

Keywords: analysts, sell-side, stock recommendations, FINRA, regulators

JEL Classification: G10, G24, G38, K22, M40, M41