Monitors or Predators: The Influence of Institutional Investors on Sell-Side Analysts

Abstract

Regulators and the investment community have been concerned that institutional investors pressure financial analysts through trading commission fees to issue optimistic opinions in support of their stock positions. We use a unique dataset that identifies mutual fund companies' allocation of trading commission fees to individual brokerages and provide direct evidence on this issue. In particular, we show that for stocks in which the fund companies have taken large positions, analysts are more optimistic in their stock recommendations when their brokerages receive trading commission fees from these fund companies. The relationship is stronger when the commission fee pressure is greater. The market reacts less favorably to the “Strong Buy” recommendations of analysts facing greater commission fee pressure. The funds also respond negatively to such recommendations in making portfolio adjustments. These results point to a source of analyst bias that has been little explored in the literature. Data Availability: The data are publically available from the sources identified in the paper.

Analyst earnings forecast under complex corporate ownership in China

“…Studies on Chinese stock analysts appear limited in scope and number in the existing literature and focus on the performance of individual analysts (for instance, Hu et al, 2008;Barniv, 2009;Barniv and Bao, 2009;Xu et al, 2013;Gu et al, 2013). Research on the quality of analysts' consensus expectations appears scant and this paper aims to contribute towards filling this gap.…”

Blurred stars: Mutual fund ratings in the shadow of conflicts of interest

“…However, this type of conflict of interest is very rare (about 1.5% of the full sample's observations). Therefore, similar to Gu et al (2013), we exclude such cases from our analysis. We discuss the details of our sample selection in the empirical specification section of the paper.…”

“…First, to our knowledge, this paper is the first to examine the effects of conflicts of interest on mutual fund star ratings, which has been overlooked in previous research on conflicts of interest in financial institutions (for a thorough literature review, see Mehran and Stulz, 2007). Using Chinese data, Firth et al (2013) and Gu et al (2013) provide evidence that conflicts of interest arising from trading commission fees cause sell-side analysts to issue optimistic recommendations on stocks held by mutual funds. Our research complements these studies by examining the impact of conflicts of interest on mutual fund star ratings.…”

“…These four brokerage houses have potential conflicts of interest in issuing fund ratings to mutual funds due to the trading commission fees they receive from mutual funds; we therefore label them brokerage MFRCs. 3 As Gu et al (2013) and Firth et al (2013) observe, mutual funds in China have to pay trading commission fees to brokerage houses to use their trading seats in the stock exchanges. The trading commission fees could induce brokerage MFRCs to bias upward the star ratings to their covered mutual funds.…”

Does Benefit Relationship Affect Analysts’ Earnings Forecast?—Evidence from Chinese Stock Market

“…However, non-underwriters analysts can forecast without concerning over underwriting relationships. (Agrawal, 2008) [19], to ensure that institutional investors gain more accurate information (Gu, 2013) [3].…”