Working Paper: NBER ID: w13124
Authors: Ulrike Malmendier; Devin Shanthikumar
Abstract: Why do security analysts issue overly positive recommendations? We propose a novel approach to distinguish strategic motives (e.g., generating small-investor purchases and pleasing management) from nonstrategic motives (genuine overoptimism). We argue that nonstrategic distorters tend to issue both positive recommendations and optimistic forecasts, while strategic distorters "speak in two tongues," issuing overly positive recommendations but less optimistic forecasts. We show that the incidence of strategic distortion is large and systematically related to proxies for incentive misalignment. Our "two-tongues metric" reveals strategic distortion beyond those indicators and provides a new tool for detecting incentives to distort that are hard to identify otherwise.
Keywords: security analysts; recommendations; strategic distortion; investor behavior
JEL Codes: D14; D82; G12; G14; G24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| analysts with misaligned incentives (G24) | overly positive recommendations (Y30) |
| analysts with misaligned incentives (G24) | less optimistic earnings forecasts (G17) |
| strategic distortion (L21) | optimism in recommendations versus forecasts (C53) |
| management pressures (M54) | optimistic recommendations (P27) |
| management pressures (M54) | lower forecasts prior to earnings announcements (G17) |
| previously distorted recommendations (D80) | likelihood of future distortion (C51) |