Do Analyst Conflicts Matter? Evidence from Stock Recommendations

We examine whether conflicts of interest with investment banking and brokerage businesses induce sell-side analysts to issue optimistic stock recommendations and, if so, whether investors are misled by such biases. Using quantitative measures of potential conflicts constructed from a novel data set containing revenue breakdowns of analyst employers, we find that recommendation levels are indeed positively related to conflict magnitudes. The optimistic bias stemming from investment banking conflicts was especially pronounced during the late-1990s stock market bubble. However, evidence from the response of stock prices and trading volumes to upgrades and downgrades suggests that the market recognizes analysts' conflicts and properly discounts analysts' opinions. This pattern persists even during the bubble period. Moreover, the 1-year stock performance following revised recommendations is unrelated to the magnitude of conflicts. Overall, our findings do not support the view that conflicted analysts are able to systematically mislead investors with optimistic stock recommendations.