Analyst Conflicts and Research Quality

Abstract

This paper examines whether the quality of stock analysts' forecasts is related to conflicts of interest from investment banking and brokerage. We consider four aspects of forecast quality: accuracy, bias and revision frequency of quarterly earnings per share (EPS) forecasts, and relative optimism in long-term earnings growth (LTG) forecasts. Using a unique dataset that contains the annual revenue breakdown of analysts' employers among investment banking, brokerage, and other businesses over the 1994-2003 period, we uncover two main findings. First, accuracy and bias in quarterly forecasts appear to be unrelated to conflict magnitudes, after controlling for forecast age, firm resources and analyst characteristics. Second, relative optimism in LTG forecasts and the frequency of revision of quarterly EPS forecasts are positively related to the importance of brokerage business to analysts' employers. Additional tests suggest that the frequency of quarterly forecast revisions is positively related to analysts' trade generation incentives. Our findings suggest that contrary to popular belief, conflicts from brokerage, rather than from investment banking, play an important role in shaping analysts' forecasting behavior.

Keywords: Stock analysts, Security analysts, Analyst conflicts, Corporate governance, Analyst forecasts, Wall Street research, Brokerage research, Conflicts of interest

JEL Classification: G24, G28, G34, G38, K22, M41