Financial analysts' silence can speak volumesResearch recently published in The Journal of Finance finds that financial analysts are incentivized to offer both favorable and accurate opinions. If analysts' stock expectations are unfavorable, they are faced with conflict. If they tell the truth, they will issue unfavorable opinions; if they don't tell the truth, the accuracy of their opinions will suffer. As a result, analysts are more likely to provide coverage only for stocks for which they have high expectations.
The authors of the study found that over a three year period, stock returns of initial public offerings followed by a high number of analysts were roughly 10 percent higher on average than those firms followed by fewer analysts.
These results indicate that financial analysts' coverage decisions effectively express their opinions of firms – either positive or negative – which in turn affect those firms' returns. The authors conclude, therefore, that analyst information would be more valuable if disincentives for truthful opinions were removed from the marketplace, placing higher value on accuracy than on favorable outcome.
This study is published in the June issue of The Journal of Finance. Media wishing to receive a PDF of this article please contact [email protected]
Somnath Das, Ph.D. is Professor and Director of Graduate Studies at the University of Illinois at Chicago. He is available for questions and comments.
Re-Jin Guo is Assistant Professor of Finance at University of Illinois at Chicago
Huai Zhang is Assistant Professor at the University of Hong Kong
The Journal of Finance publishes leading research across all the major fields of financial research. It is the most widely cited academic journal on finance. For more information on the journal and the American Finance Association, visit www.afajof.org
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