Conflicts of Interest in the Stock Recommendations of Investment Banks and Their Determinants

Abstract

This study explores the phenomena associated with conflicts of interest, particularly as they pertain to the brokerage and proprietary trading divisions of investment banks. This distinguishes it from past studies, which have researched conflicts of interest between underwriting and brokerage divisions. We examine whether or not an investment bank issues buy recommendations to the market and buys (sells) the same recommended stocks through its proprietary trading division before (after) recommendations, and if so, to what extent this goes on. We find that these conflicts of interest do exist and that these investment banks can profit from their recommendations in the short run.

The time‐varying performance of UK analyst recommendation revisions: Do market conditions matter?

“…The existing research attributes the value of analyst recommendations to a variety of factors, such as conflicts of interest (see, Mehran & Stulz, 2007; Shen & Chih, 2009), analyst reputation (see, Emery & Li, 2009; Fang & Yasuda, 2009, 2014; Kucheev, Ruiz, & Sorensson, 2017), industry (see, Boni & Womack, 2006; Bradley, Gokkaya, & Liu, 2017; Merkley, Michaely, & Pacelli, 2017), timing (see, Green, 2006; Irvine, Lipson, & Puckett, 2007; Ivkovic & Jegadeesh, 2004), herding (see, Jegadeesh & Kim, 2010; Trueman, 1994), and so on. A very recent study by Loh and Stulz (2018) argues that the usefulness and performance of analysts could be dependent on bad market conditions, though little attention has been paid to this hypothesis.…”

Perception alignment hypothesis: causality of herding?

“…The Global Research Analyst Settlement in 2003 generated more recent interest in the manipulative act by sell-side analysts (Choi et al , 2015; De Franco et al , 2007; Irvine et al , 2007; Li and Heidle, 2004; Lin and Kuo, 2007; Proimos, 2005; Shen and Chih, 2009). In essence, sell-sided analysts announce overly optimistic recommendation revisions to the investing public and align numerous investors’ perceptions according to the desire of the analysts.…”

Can We Trust Financial Analysts? Reliability of Stock Recommendations and Firm-Specific Characteristics

“…9; forecasts and recommendations has also been studied in the presence of some determinants such as analysts' conflict of interest and analysts' expertise (Ertimur, Sunder, & Sunder, 2008). Other factors have been analysed in connection with stock recommendations, such as the type of analysts' affiliation (Lin & McNichols, 1998;Michaely & Womak, 1999), the conflict of interest between a proprietary trading division and a brokerage division (Shen & Chih, 2009), the role of analyst optimism (Mokoaleli-Mokoteli, Taffler, & Agarwal, 2009) and the investor sentiment (Bagnoli, Clement, Crawley, & Watts, 2009). …”