Is there a 'Quid Pro Quo' between Hedge Funds and Sell-Side Equity Analysts?

Abstract

In this article, the authors posit a quid pro quo in economic benefits between sell-side equity analysts and large hedge fund managers. They show that large hedge funds opportunistically trade one to four days prior to the publication of a recommendation change, a finding consistent with flow of information from analysts to hedge funds. Next, the authors demonstrate that in return for the information provided, analysts benefit from (1) better external evaluations and (2) higher trading commissions and fees for their brokerage firm. Notably, pre-trading occurs only when the analyst issuing the recommendations has a high external evaluation and the analyst’s brokerage house is a prime broker to the hedge fund.

Keywords: Trading on private information; Hedge funds; Sell-side analysts

JEL Classification: G12; G23; G24