Investors’ Reliance on Analysts’ Stock Recommendations and Mitigating Mechanisms for Potential Overreliance

42 Pages Posted: 3 Jun 2011 Last revised: 5 Jun 2011

See all articles by Khim Kelly

Khim Kelly

University of Central Florida

Bernardine M. Low

Nanyang Technological University (NTU)

Hun-Tong Tan

Nanyang Business School, Nanyang Technological University

Seet-Koh Tan

Nanyang Technological University (NTU) - Division of Accounting

Multiple version iconThere are 2 versions of this paper

Date Written: May 31, 2011

Abstract

We conduct three experiments to investigate whether and why investors rely on analysts’ stock recommendations, and how to mitigate potential overreliance. In Experiments 1 and 2, we find that investors who receive a buy (sell) recommendation judge a company to have higher (lower) investment potential, holding all other information constant. Warning investors about potential bias in recommendations and requiring them to form an independent stock recommendation reduce a buy recommendation’s effect on investors’ judgments, but do not reduce a sell recommendation’s effect on investors’ judgments. In Experiment 3, we find that merely disclosing the analyst firm’s distribution of stock recommendations as per current FINRA/NYSE stock exchange rules does not reduce the effects of a buy recommendation associated with a distribution skewed toward buys, unless accompanied by a warning about potential bias in overly-skewed distributions or a warning plus a requirement to form an independent recommendation. Lastly, investors indicate that they rely on analysts’ recommendations based on beliefs about the analyst’s ability to generate trading interest, expertise in evaluating information, and access to information. Warning about analyst bias plus inducing independent judgment temper those beliefs, and those beliefs mediate the effects of warning and independent judgment on investors’ judgments.

Keywords: Analyst Recommendations, Analyst Bias, Analyst Disclosures, Investor Judgments, NASD Rule 2711

JEL Classification: C91, M41

Suggested Citation

Kelly, Khim and Low, Bernardine M. and Tan, Hun-Tong and Tan, Seet-Koh, Investors’ Reliance on Analysts’ Stock Recommendations and Mitigating Mechanisms for Potential Overreliance (May 31, 2011). Available at SSRN: https://ssrn.com/abstract=1856350 or http://dx.doi.org/10.2139/ssrn.1856350

Khim Kelly

University of Central Florida ( email )

12744 Pegaus Dr
Orlando, FL 32816
United States

Bernardine M. Low

Nanyang Technological University (NTU) ( email )

S3 B2-A28 Nanyang Avenue
Singapore, 639798
Singapore

Hun-Tong Tan

Nanyang Business School, Nanyang Technological University ( email )

Singapore, 639798
Singapore
+65 6790 4819 (Phone)
+65 6793 7956 (Fax)

Seet-Koh Tan (Contact Author)

Nanyang Technological University (NTU) - Division of Accounting ( email )

Singapore, 639798
Singapore

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