The Value of Analysts' Recommendations and the Organization of Financial Research

Abstract

Brokerage houses usually organize their research activities by country or economic sector. We evaluate which research structure provides most value to investors. To do so, we study the relative information content of recommendations issued by country-specialized analysts and sector-specialized analysts. Our findings show that the former issue more valuable recommendations. The strength of country-specific commonalities explains at least part of the better performance of country-specialized financial analysts. Surprisingly, although analysts' geographic location has been shown in the literature to be a determinant of earnings forecast accuracy, it is not a source of a comparative advantage when it comes to stock recommendations.

Is Diversification a Job Safety Net for Sell‐side Analysts?

“…The literature assesses both exogenous (i.e., imposed by a brokerage house) and endogenous (i.e., analyst's choice) factors that determine degree of diversification. Exogenous factors include historical and cultural features of brokerages and characteristics of employing brokerage houses (Kini et al 2009;Sonney 2009;Salva and Sonney 2011). Most U.S. brokers have historically organized research using an industry-based organizational structure, whereas European brokers focus on countries.…”

“…Although Myring and Wrege (2009) document that from 1984 to 2006 individual analysts had greater industry specialization and achieved greater forecasting accuracy, more than 60% of analysts remain diversified. Several studies attempt to explain this phenomenon (Kini et al 2009;Sonney 2009;Salva and Sonney 2011;Muslu, Rebello, and Xu 2014; The authors acknowledge partial financial support from the David Whitcomb Center for Research in Financial Services of Rutgers University. All errors are our own.…”

“…When career concerns are more severe, analysts are less likely to issue bold forecasts, are more opportunistic, and change coverage choices (Nolte, Nolte, and Vasios 2014;Horton, Serafeim, and Wu 2017;Li, Rau, and Xu 2009). Most studies that investigate conflicts of interest focus on misalignment between brokerage houses' and their clients' 4 Other evidence suggests that analysts' choice of industry coverage is not random (Kini et al 2009;Sonney 2009;Salva and Sonney 2011;Muslu, Rebello, and Xu 2014;Hameed et al 2015;O'Brien and Tan 2015). interests. 5 We highlight a conflict of interest between analysts and their clients that drives diversification decisions.…”

Stock recommendations and investment portfolio formation: A study in the Brazilian market

“…Naturally, it is the analysts' role to help investors identify profitable investment opportunities. Francis and Soffer (1997) and Salva and Sonney (2011) find the analysts' stock recommendations form the final result of researches on companies and their markets, and reflect an expert and global opinion on the stock value in relation to its market price. Likewise, they can affect the behavior of the paper prices.…”