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Review of Accounting Studies
Erschienen in: Review of Accounting Studies 4/2019

02.08.2019

Changes in analysts’ stock recommendations following regulatory action against their brokerage

verfasst von: Andrew C. Call, Nathan Y. Sharp, Paul A. Wong

Erschienen in: Review of Accounting Studies | Ausgabe 4/2019

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Abstract

Despite the importance of sell-side analysts in the capital markets, we know little about the effectiveness of routine monitoring of the sell-side industry. We examine the attributes of sell-side research issued by analysts before and after their brokerage faces regulatory sanctions. We find that after a sanction, analysts at sanctioned brokerages lower their stock recommendations, both in absolute terms and relative to the recommendations of other analysts following the same firms. These analysts are also more likely than analysts at other brokerages to downgrade a company’s stock after the receipt of unfavorable information about the firm. Importantly, we document that analysts at nonsanctioned brokerages also reduce the optimism of their stock recommendations when a peer analyst’s brokerage is sanctioned, consistent with spillovers as a result of routine regulatory monitoring. Our study provides evidence that regulatory action against sell-side brokerages is associated with a reduction in sell-side analysts’ positive bias.
Vorheriger Artikel Key performance indicators as supplements to earnings: Incremental informativeness, demand factors, measurement issues, and properties of their forecasts
Nächster Artikel Do financial analysts compel firms to make accounting decisions? Evidence from goodwill impairments

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Fußnoten
1
We also note that the frequency of an audit by FINRA is a function of the broker’s size and business model (Pacelli 2019). The discovery of misconduct may be more likely at larger, more complex brokerages that are subject to more frequent audits. However, it may be more difficult for a regulator to identify misconduct at a large, complex broker. Our tests do not model the probability of misconduct being discovered at a given brokerage and instead take FINRA violations as given and examine the consequences of these sanctions.
 
2
We obtain all of the regulatory actions in our sample through FINRA’s BrokerCheck service, and most actions (72%) are initiated by FINRA or its predecessor. Other regulators, such as the Securities and Exchange Commission, initiate regulatory actions when securities laws are violated, and these violations are also included in BrokerCheck. For parsimony, we refer to all actions in our sample as regulatory actions by FINRA.
 
3
The IBES recommendation file contains the analyst’s first initial, last name, and an abbreviated name of the brokerage releasing the recommendation.
 
4
FINRA’s BrokerCheck website provides both the date that the regulatory action was initiated and the date that it was resolved. We focus on the date the regulatory action was initiated and examine the first stock recommendation issued after this date.
 
5
We modify SR to create three recommendation level categories (buy, hold, and sell) and find similar results.
 
6
Logistic regression containing numerous fixed effects have the potential for bias in the estimated coefficients (Greene 2004). We re-estimate our tests of the likelihood of a downgrade using an OLS regression, and our inferences are the same.
 
7
In untabulated results, we also find that, in the year following FINRA events, analysts at sanctioned brokerages issue less optimistically biased (and more accurate) earnings and target price forecasts.
 
8
Relatedly, a stock recommendation in the pre-sanction period for one analyst may coincide with a stock recommendation in the post-sanction period for a different analyst covering the same firm but employed by a different brokerage.
 
9
Kadan et al. (2009) conduct a thorough examination of the Global Settlement and other regulations on analysts’ stock recommendations, and note that following these regulations most brokerages migrated from a five-tier to a three-tier rating system. In our tests, we employ the same system used by the brokerage at the time the analyst issued the forecast, noting that our inferences are robust to the use of a three-tier (rather than five-tier) recommendation rating system throughout.
 
10
We find no difference in behavior following FINRA violations based on the size of the sanctioned brokerage, suggesting that the effect we document is not limited to only analysts employed by small brokerages. Note, however, that the analysts at sanctioned brokerages who were most optimistic prior to the sanction are associated with the largest reductions in stock recommendation optimism following the sanction.
 
11
We also omit year fixed effects because all stock recommendations issued by the analysts at sanctioned brokerages and by the corresponding analysts at nonsanctioned brokerages are issued within 90 days of the same earnings announcement. However, note that our findings are robust to the inclusion of year fixed effects.
 
12
Note that many violations classified as being associated with the issuance of misleading research also include other types of violations (e.g., conflicts of interest associated with investment banking). See Appendix 1 for specific examples.
 
13
The combined effect of Post_Action and Post_Action*Upgrade is not statistically different from zero (p value = 0.611).
 
14
These results should not be interpreted to mean that all analysts lower their stock recommendations for all firms they follow after a regulatory action against one brokerage. Importantly, this analysis focuses only on the subset of firms followed by analysts at a sanctioned brokerage. The majority of covered firms are not included in this analysis, and analysts are much less likely to revise their stock recommendations for those firms in response to these regulatory actions.
 
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Metadaten
Titel
Changes in analysts’ stock recommendations following regulatory action against their brokerage
verfasst von
Andrew C. Call
Nathan Y. Sharp
Paul A. Wong
Publikationsdatum
02.08.2019
Verlag
Springer US
Erschienen in
Review of Accounting Studies / Ausgabe 4/2019
Print ISSN: 1380-6653
Elektronische ISSN: 1573-7136
DOI
https://doi.org/10.1007/s11142-019-09506-y

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