The Faith in Peril: Do Financial Analysts Overestimate Political Connections?

Abstract

We examine the superiority of political connections in the Chinese capital market through the lens of analysts' forecast optimism. We find that politically firms receive more optimistic earnings forecasts than their unconnected counterparties in the presence of stock crashes. Further analysis shows that the central inspection, considered as a threat to the connection, widely weakens such overestimation effect. Moreover, this bias is proven to be driven by the attribution bias and thus the overconfidence into the political connections. Busier or less competent analysts are more likely to overestimate the political connections. Their overoptimistic forecast is associated with more net inflows of main funds by block traders into the connected firms, which, however, do not translate into the improvement of corporate fundamentals in the post-crash period. Collectively, these pieces of evidence suggest that analysts have subjectively overestimated the effect of political connections and might bring in a misallocation of financial liquidity.

Keywords: Analyst research, Political connection, Attribution bias, Overconfidence

JEL Classification: D91; G01; G14; G24; N25