The Client is King: Do Mutual Fund Relationships Bias Analyst Recommendations?

Forthcoming, Journal of Accounting Research

44 Pages Posted: 19 Mar 2009 Last revised: 12 Sep 2012

See all articles by Michael Firth

Michael Firth

Lingnan University - Department of Finance and Insurance

Chen Lin

The University of Hong Kong - Faculty of Business and Economics

Ping Liu

Krannert School of Management, Purdue University

Yuhai Xuan

University of California, Irvine - Paul Merage School of Business

Date Written: September 11, 2012

Abstract

This article investigates whether the business relations between mutual funds and brokerage firms influence sell-side analyst recommendations. Using a unique data set that discloses brokerage firms’ commission income derived from each mutual fund client as well as the share holdings of these mutual funds, we find that an analyst’s recommendation on a stock relative to consensus is significantly higher if the stock is held by the mutual fund clients of the analyst’s brokerage firm. The optimism in analyst recommendations increases with the weight of the stock in a mutual fund client’s portfolio and the commission revenue generated from the mutual fund client. However, this favorable recommendation bias towards a client’s existing portfolio stocks is mitigated if the stock in question is highly visible to other mutual fund investors. Abnormal stock returns are significantly greater both for the announcement period and in the long run for favorable stock recommendations from analysts not subject to client pressure than for equally favorable recommendations from business-related analysts. In addition, we find that subsequent to announcements of bad news from the covered firms, analysts are significantly less likely to downgrade a stock held by client mutual funds. Mutual funds increase their holdings in a stock that receives a favorable recommendation but this impact is significantly reduced if the recommendation comes from analysts subject to client pressure.

Keywords: Business relations, Analyst recommendations, Mutual fund, Client pressure

JEL Classification: G20, G24, G30

Suggested Citation

Firth, Michael and Lin, Chen and Liu, Ping and Xuan, Yuhai, The Client is King: Do Mutual Fund Relationships Bias Analyst Recommendations? (September 11, 2012). Forthcoming, Journal of Accounting Research. Available at SSRN: https://ssrn.com/abstract=1363773 or http://dx.doi.org/10.2139/ssrn.1363773

Michael Firth

Lingnan University - Department of Finance and Insurance ( email )

Castle Peak Road
Tuen Mun, New Territories
Hong Kong
China
+852 2616 8160 (Phone)
+852 2466 4751 (Fax)

Chen Lin

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

Ping Liu

Krannert School of Management, Purdue University ( email )

1310 Krannert Building
West Lafayette, IN 47907-1310
United States
7654944691 (Phone)

Yuhai Xuan (Contact Author)

University of California, Irvine - Paul Merage School of Business ( email )

4291 Pereira Drive
Irvine, CA California 92697-3125
United States

HOME PAGE: http://yuhai.merage.uci.edu/

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