Strategic Distortions in Analyst Forecasts in the Presence of Short-Term Institutional Investors

Abstract

We document that analysts cater to short-term investors by issuing optimistic target prices. Catering dominates among analysts at brokers without an investment banking arm as they face lower reputational cost. The market does not see through the analyst catering activity and their forecasts lead to temporary stock overpricing that short-term institutional investors exploit to offload their holdings to retail traders. We also report evidence consistent with catering brokers being rewarded with more future trades channelled through them. Our study identifies a new source of conflicts of interest in analyst research originating from the ownership composition of a stock.

Keywords: Target prices; Earnings forecasts; Strategic distortions; Short-term investors

JEL Classification: G14; G24; G29; D82; D83