Chinese Walls in German Banks

Analysts in a bank's research department cover firms that have no relationship with the bank as well as companies in which the bank has a strategic interest. Officially, banks must establish Chinese Walls around their research departments to allow the analysts to work independently and to avoid the flow of insider information. We examine analyst behavior under long-term bank-firm relationships using ownership data and analysts' earnings per share forecasts for German companies from 1994 to 2001. We find evidence that is consistent with analysts reconciling their employers' interests with their own career concerns. They seem to use their information advantage strategically by releasing favorable and thereby more precise reports when the market underestimates earnings. In order not to jeopardize the bank-client relationship, they suppress negative information when the market is too optimistic. Combining situations where the market over- and underestimates earnings, we can replicate the unconditional positive bias in analyst forecasts found in the previous literature. Despite the bias in affiliated analysts' forecasts, they nonetheless selectively communicate valuable information to investors. Copyright 2006, Oxford University Press.