Broker Trading Volume and Analysts’ Earnings Forecasts: A Conflict of Interest?*

Abstract

Using unique new data, we examine whether brokerage trading volume creates a conflict of interest for analysts’ earnings forecasts. We find that forecast optimism is associated with higher brokerage volume, even controlling for forecast and analyst quality, recommendations, and target prices. When analysts change brokerage firms, they bring this trading volume with them, influencing trading volume at the new brokerage house. This indicates that analysts drive the volume effects we observe. Consistent with a reward for generating volume, brokerage houses are less likely to demote analysts who generate more volume. Finally, analysts strategically adjust forecast optimism based on expected volume impact. Analysts become more (less) optimistic if their optimistic forecasts in the prior year were more (less) successful at generating volume. Overall, our results are consistent with a brokerage trading volume conflict of interest moving analysts towards more optimistic earnings forecasts.

Keywords: Sell-side analysts, brokerage houses, trading volume, commissions, conflicts of interest, incentives, earnings forecasts

JEL Classification: G24, M40, D83