Brokerage House Reputation, Underwriting Relationships, and Analysts Earnings Forecasts in UK Firms

Abstract

The purpose of this paper is to examine the extent to which analyst's earnings forecasts are influenced by brokerage house reputations in a UK setting. We use an I/B/E/S detail earnings estimate history file, an SDC dataset for providing data on IPO underwriting activities (proceeds, underwriting fees, and management fees), and data provide by the Institutional Investor (All-Europe Research Team rankings) for the period June 1987 to March 2002. In short, we find that analyst's earnings forecasts are primarily influenced by brokerage house reputations but not by the proceeds of the IPO's or the underwriting and management fees charged for such services. In particular, we find analysts that issue estimates on firms for which their brokerage houses were the lead managing underwriter are statistically significant more optimistic than for firms they issue estimates on, in which their brokerage houses were not associated with any underwriting activity. Moreover, we also find evidence that there is some bias in the buy recommendations analysts issue for these firms. In summary, our findings suggest that analyst's forecasts are biased and more optimistic with respect to a brokerage firms' underwriting relationships. However, we do not find evidence that this optimism bias is due to incentive based compensation suggesting a non-incentive based theory may apply.

We make the following acknowledgements regarding this paper. First, we are grateful for the financial support provided by The Leverhulme Trust and INQUIRE, EUROPE. Second, we thank the contribution of Thomson Financial for providing data, available through the Institutional Brokers Estimate System I/B/E/S. This data has been provided as part of a broad academic program to encourage earnings expectations research.

Keywords: Analysts earnings forecasts, underwriting relationships, sell-side firms, brokerage houses, optimism

JEL Classification: G14, G12, G15, G29