"Analysts face
incentives to positively bias the information they provide to investors. These incentives are reflected in the very low number of sell and strong sell recommendations issued by all analysts, in particular by
affiliated analysts. We find that small
investors do not adjust for the incentives of an
Analyst who faces an underwriting affiliation. While large investors do not place buy pressure on a stock following an affiliated buy or strong buy recommendation, small investors do. Large investors react more weakly to positive affiliated recommendations than to unaffiliated recommendations, while small
traders react almost exactly the same to both affiliated and unaffiliated recommendations. Return results show that following affiliated recommendations consistently earns lower returns than following unaffiliated recommendations, over many possible time horizons, and with many portfolio strategies. Small traders make losses by naively following affiliated analyst recommendations. Finally, additional competition does not seem to solve the problem. Affiliated
Analysts issue even higher recommendations when they face more competition. It is possible that small traders simply cannot identify underwriting affiliation, or that it is too costly for them to research an analyst's background. In this case, investors should react more cautiously to recommendations in general, but instead our abnormal trade imbalance results suggest that small traders react more strongly to the general recommendation than large traders. Alternatively, small traders should focus on analysts from non-underwriting firms. Instead, small traders react less to these analysts. Our results thus far indicate that analyst incentives affect their recommendations, with competition among analysts failing to mitigate the effect, and that small investors fail to account for these distortionary incentives. Overall, the traditional economic assumption of uninformed agents taking into account the incentives of informed agents, does not seem to hold for small investors in the market for information about stocks".
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