Buy-Side Analysts, Sell-Side Analysts, and Investment Decisions of Money Managers

Abstract

We examine the role of financial analysts in forming institutional investors' investment decisions. We model how a fund manager invests in a stock based on reports produced by a biased sell-side analyst and an unbiased buy-side analyst. She weighs the two reports in her decision making, and puts a higher weight on the buy-side analyst's report when the quality of the buy-side analyst's information relative to that of the sell-side analyst increases, or when the sell-side analyst's degree of bias or the uncertainty in the bias increases. Utilizing a unique data set of U.S. equity funds with description of fund organizational structure and research sources, we find empirical evidence supporting our model predictions on how fund managers weigh buy-side research relative to sell-side and independent research.

Keywords: Buy-side analyst, sell-side analyst, bias, earnings forecast, excess return.

JEL Classification: G29, D82, G10