Analysts’ Incentive- and Cognitive-Based Processing Biases: Evidence from Recommendation Revisions

44 Pages Posted: 25 Aug 2009 Last revised: 17 Jun 2018

See all articles by Ruei-Shian Wu

Ruei-Shian Wu

Yuan Ze University

Hsiou-Wei Lin

National Taiwan University

Date Written: November 24, 2009

Abstract

This paper examines how incentive-based and behavior-based variables affect analyst recommendation revisions. Specifically, we use duration analysis to test analysts' underreaction to new information by isolating effects of incentives and cognitive processing biases (i.e., cognitive dissonance and conservatism) on the timing of their recommendation revisions. In an unconditioned circumstance, the results show that analysts are not biased against conveying negative signals. However, when we control for favorable preceding recommendations, we find that analysts delay conveying bad news, which is consistent with the incentives and cognitive dissonance hypotheses. When we control for unfavorable preceding recommendations, the results show that analysts delay conveying good news, which is only consistent with the cognitive dissonance hypothesis. We also find that analysts delay their responses to new favorable information for outperformers from which they have received low representative information relative to high representative information. Our results provide direct evidence that analysts' underreaction to new information is compounded by the effect of conservatism, which suggests that individuals do not update their beliefs adequately in the face of new evidence.

Keywords: Analyst recommendation, Cognitive dissonance, Conservatism, Underreaction

JEL Classification: G14, M41

Suggested Citation

Wu, Ruei-Shian and Lin, Hsiou-Wei, Analysts’ Incentive- and Cognitive-Based Processing Biases: Evidence from Recommendation Revisions (November 24, 2009). Asia-Pacific Journal of Accounting & Economics, 21:4, 443-471, 2014. Available at SSRN: https://ssrn.com/abstract=1460657 or http://dx.doi.org/10.2139/ssrn.1460657

Ruei-Shian Wu (Contact Author)

Yuan Ze University ( email )

135 Yuan-Tung Road
Chung-Li, 32003
Taiwan
886-3-4638800#2195 (Phone)
886-3-4633845 (Fax)

Hsiou-Wei Lin

National Taiwan University ( email )

1 Sec. 4, Roosevelt Road
Taipei, 106
Taiwan

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