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Behavioural Bias and Conflicts of Interest in Analyst Stock Recommendations

Authors

  • Thabang Mokoaleli-Mokoteli,

    1. The first author is Senior Lecturer in Accounting, Wits Business School, University of the Witwatersrand, Johannesburg, Republic of South Africa. The second author is Martin Currie Professor of Finance and Investment, University of Edinburgh. The third author is Lecturer in Finance, Cranfield School of Management. This paper has considerably benefited from the helpful comments of the anonymous JBFA referee, Martin Walker (editor) and, inter alia, Veljko Fotak, Wayne Landsman, Danielle Lyssimachou, Leonardo Madureira, Stuart McLeay, Barry Morse, Peter Pope, Rodney Rogers, Brian Rountree and Paul Ryan, as well as participants at the European Financial Management Behavioural Finance Symposium, University of Durham, April 2006, the Financial Reporting and Business Communications Conference, Cardiff University, July 2006, the British Accounting Association Scottish Area Group Meeting, Glasgow Caledonian University, September 2006, the European Financial Management Association Meeting, Vienna University of Economics and Business Administration, June 2007, the Financial Management Association Annual Meeting, Orlando, October 2007, a staff research seminar at the University of Reading, November 2007 and, especially, the 16thJBFA Capital Markets Conference, University of Lancaster, May 2008.
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  • Richard J. Taffler,

    1. The first author is Senior Lecturer in Accounting, Wits Business School, University of the Witwatersrand, Johannesburg, Republic of South Africa. The second author is Martin Currie Professor of Finance and Investment, University of Edinburgh. The third author is Lecturer in Finance, Cranfield School of Management. This paper has considerably benefited from the helpful comments of the anonymous JBFA referee, Martin Walker (editor) and, inter alia, Veljko Fotak, Wayne Landsman, Danielle Lyssimachou, Leonardo Madureira, Stuart McLeay, Barry Morse, Peter Pope, Rodney Rogers, Brian Rountree and Paul Ryan, as well as participants at the European Financial Management Behavioural Finance Symposium, University of Durham, April 2006, the Financial Reporting and Business Communications Conference, Cardiff University, July 2006, the British Accounting Association Scottish Area Group Meeting, Glasgow Caledonian University, September 2006, the European Financial Management Association Meeting, Vienna University of Economics and Business Administration, June 2007, the Financial Management Association Annual Meeting, Orlando, October 2007, a staff research seminar at the University of Reading, November 2007 and, especially, the 16thJBFA Capital Markets Conference, University of Lancaster, May 2008.
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  • Vineet Agarwal

    Corresponding author
    1. The first author is Senior Lecturer in Accounting, Wits Business School, University of the Witwatersrand, Johannesburg, Republic of South Africa. The second author is Martin Currie Professor of Finance and Investment, University of Edinburgh. The third author is Lecturer in Finance, Cranfield School of Management. This paper has considerably benefited from the helpful comments of the anonymous JBFA referee, Martin Walker (editor) and, inter alia, Veljko Fotak, Wayne Landsman, Danielle Lyssimachou, Leonardo Madureira, Stuart McLeay, Barry Morse, Peter Pope, Rodney Rogers, Brian Rountree and Paul Ryan, as well as participants at the European Financial Management Behavioural Finance Symposium, University of Durham, April 2006, the Financial Reporting and Business Communications Conference, Cardiff University, July 2006, the British Accounting Association Scottish Area Group Meeting, Glasgow Caledonian University, September 2006, the European Financial Management Association Meeting, Vienna University of Economics and Business Administration, June 2007, the Financial Management Association Annual Meeting, Orlando, October 2007, a staff research seminar at the University of Reading, November 2007 and, especially, the 16thJBFA Capital Markets Conference, University of Lancaster, May 2008.
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* Address for correspondence: Richard J. Taffler, Martin Currie Professor of Finance and Investment, University of Edinburgh Business School, William Robertson Building, 50 George Square, Edinburgh, EH8 9JY, UK.
e-mail: Richard.Taffler@ed.ac.uk

Abstract

Abstract:  This paper tests whether sell-side analysts are prone to behavioural errors when making stock recommendations as well as the impact of investment banking relationships on their judgments. In particular, we analyse their report narratives for evidence of cognitive bias. We find first that new buy recommendations on average have no investment value whereas new sell recommendations do, and take time to be assimilated by the market. We also show that new buy recommendations are distinguished from new sells both by the level of analyst optimism and representativeness bias as well as with increased conflicts of interest. Successful new buy recommendations are characterised by lower prior returns, value stock status, smaller firms and weaker investment banking relationships. On the other hand, successful new sells do not differ from their unsuccessful counterparts in terms of these measures. As such, we provide evidence that analysts are prone both to behavioural bias as well as potential conflicts of interest in their new buy stock recommendation decisions. We also show that these two explanations of analyst behaviour are to a great extent independent of each other. Consequently, the recent attempts by regulators to address potential conflicts of interest in analyst behaviour may have only limited impact.

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