Conflicts of Interest and Analyst Behavior: Evidence from Recent Changes in Regulation

Regulation FD made analysts less dependent on insider information and diminished analysts’ motives to inflate their forecasts. The Global Research Analyst Settlement had an even bigger impact on analyst behavior: The mean forecast bias declined significantly, whereas the median forecast bias essentially disappeared. These results are similar for all analysts. In the early part of the first decade of this century, in an effort to restore public confidence in U.S. capital markets, U.S. regulators enacted several rules and regulations, prosecuted analysts whose research reports were tainted by conflicts of interest, and fined banks that failed to prevent research analysts’ conflicts of interest. Two of the main regulatory developments during this period were (1) Regulation Fair Disclosure (Reg FD), which became effective on 23 October 2000, and (2) the Global Research Analyst Settlement (Global Settlement), which was announced on 20 December 2002. We examined whether these two actions by U.S. regulators reduced the bias in analysts’ earnings forecasts documented in prior studies.We obtained sell-side analysts’ earnings forecasts for fiscal year-end dates between 1996 and 2006 from the I/B/E/S Detail file. We documented that analysts’ conflicts of interest were evident prior to the Global Research Analyst Settlement and were not limited to the 12 banks covered by it. Analysts tended to make overoptimistic earnings forecasts prior to Reg FD and the Global Settlement.Reg FD made analysts less dependent on insider information and thus diminished analysts’ motives to favor company managers by inflating their earnings forecasts. The impact of Reg FD is more significant for companies with a less transparent information environment in which insider information has the most value.Introduced in 2002, the Global Settlement and related regulations had an even bigger impact than Reg FD on analyst behavior. After the Global Settlement, the mean forecast bias declined significantly, whereas the median forecast bias essentially disappeared. Although disentangling the impact of the Global Settlement from that of related rules and regulations aimed at mitigating analysts’ conflicts of interest is impossible, forecast bias clearly declined around the time the Global Settlement was announced. These results suggest that the recent efforts of regulators have helped neutralize analysts’ conflicts of interest.