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Competition and opportunistic advice of financial analysts: theory and evidence

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  • Sette, Enrico

Abstract

This work investigates both theoretically and empirically how the behaviour of financial analysts is affected by competition, measured as the strength of coverage of a stock from other analysts. The interaction among analysts and investors is modelled as a dynamic cheap talk game. The theoretical model shows that analysts having a conflict of interest with investors, report information truthfully with higher probability if other, “neutral”, analysts report information on the same stock. This empirical prediction is tested on data about recommendations on IPOs. The main result is that analysts working for the lead underwriter of the IPO (“insiders”) are more optimistic when there are no other analysts (not working for the lead underwriter, “outsiders”) covering the stock. The data also show that insiders do not seem to use the information contained in outsiders recommendations. Finally, outsiders are not influenced by recommendations previously issued by insiders. These results also allow to discriminate between competing hypothesis brought forward to explain insider’s overoptimism. The empirical evidence suggests that insider analysts overoptimism is induced by incentives rather than by a “psychological bias”.

Suggested Citation

  • Sette, Enrico, 2007. "Competition and opportunistic advice of financial analysts: theory and evidence," LSE Research Online Documents on Economics 24487, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:24487
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    File URL: http://eprints.lse.ac.uk/24487/
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    References listed on IDEAS

    as
    1. Andrew R. Jackson, 2005. "Trade Generation, Reputation, and Sell‐Side Analysts," Journal of Finance, American Finance Association, vol. 60(2), pages 673-717, April.
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    competition; financial analysts; IPOs; recommendations;
    All these keywords.

    JEL classification:

    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • D40 - Microeconomics - - Market Structure, Pricing, and Design - - - General

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