Skip to main content
SpringerLink
Log in

Was the Global Settlement Effective in Mitigating Systematic Bias in Affiliated Analyst Recommendations?

  • Published:
Journal of Business Ethics Aims and scope Submit manuscript

Abstract

Regulators have recently relaxed some provisions of the Global Research Analyst Settlement of 2003 (the “Global Settlement”) and associated reforms, which arose from charges that conflicts of interest within investment banks had induced the issuance of fraudulent or otherwise misleading analyst research reports. We examine the effectiveness of the Global Settlement in reducing the systematic optimism observed in stock recommendations of analysts whose employer is a merger and acquisition (“M&A”) advisor for the covered firm (“affiliated analysts”), by comparing the optimism exhibited in stock recommendations issued by these analysts and by unaffiliated analysts before and after the Global Settlement. To control for the impact on analyst optimism of other time varying factors, our sample includes cases from the US and from other countries in which the Global Settlement had no direct impact. We argue that if the Global Settlement was effective, there should be a reduction in the relative optimism of affiliated analysts following this reform, and that reduction in the relative optimism should be greater for affiliated US analysts, than for affiliated analysts from non-US countries. When optimism is measured over a 180-day period surrounding the M&A announcement, we find a significantly greater reduction in US affiliated analysts’ optimism than occurs outside the US. However, evidence regarding analysts’ optimism in the 90-day period prior to the announcement of an M&A deal is mixed.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Fig. 1

Similar content being viewed by others

Notes

  1. The regulatory silence in regard to affiliated analyst behaviour surrounding M&A transactions was clarified in 1997, when the SEC affirmed that it would not prohibit affiliated analysts from publishing reports while deals were pending (Kolasinski and Kothari 2008, p. 821).

  2. Related literature (e.g. Jackson 2005) examines incentives to bias analyst reports arising from the desire to generate trading volume (and thus brokerage fees) from clients. Other studies examine difference in recommendation properties across analysts employed by investment banks and other analysts (Cowen et al. 2006), and the relative importance of investment banking revenues to the analysts’ employer (Agrawal and Chen 2008, 2012).

  3. For simplicity in our hypotheses the phrase ‘Global Settlement’ subsumes the related regulatory changes introduced in 2002 and 2003.

  4. The provisions of the GS are applicable only in regard to research conducted on US companies or foreign companies for which the US is the principal equity trading market (see Global Research Analysts Settlement, Addendum A, Section II Part 3 at http://www.sec.gov/litigation/litreleases/finaljudgadda.pdf).

  5. The chosen event window reflect the fact that acquirers have typically retained their advisors at least 3 months prior to the announcement date (Kolasinski and Kothari 2008, pp. 820–821), and thus statistical noise caused by the possibility that unsuccessful tenderers for the advisory deal may bias their recommendations is reduced.

  6. We employ alternate definitions in our additional tests.

  7. Untabulated sensitivity tests find no substantive difference in results if we convert all observations of DEALVALUE to their 1992 purchasing power equivalent.

  8. The UK and Australia were selected as control countries, due to their similarities with the US in regard to the legal, accounting and economic systems and the importance of equity markets as a source of capital.

  9. Although the GS reforms were approved by the Supreme Court on 15 March 2010, any impact of these reforms on analyst behaviour is likely to have taken several months in which to manifest in such a way as to impact our tests. The investment banking and research work surrounding M&A deals typically commences several months before the M&A announcement date. For this reason, we allow our main sample period to extend to the beginning of 2011. All results reported in this paper are similar if we restrict our sample to M&A announcement dates prior to 15 March 2010.

  10. The incidence of affiliated forecasts for non-US M&A transactions is relatively low, especially for UK. One reason for this is that in the UK and Australia a significant minority (approximately 17 % in our SDC sample) of acquirers retain an accounting firm rather than investment bank as their acquisition advisor. There is also a greater proportion of non-US brokerages identified in SDC who cannot be reliably matched to an estimator identifier in I/B/E/S.

  11. The results discussed here are for models holding control variables constant at their respective means. Sensitivity tests using the median, and mean ± 1 SD values of the statistically significant covariates generate similar results.

Abbreviations

GAO:

US Government Accounting Office

GS:

Global Research Analyst Settlement

IB:

Investment banking

IPO:

Initial public offering

JOBS:

Act Jumpstart Our Business Startups Act 2012

M&A:

Merger and acquisition

NASD:

National Association of Securities Dealers

NYAG:

New York State Attorney General

NYSE:

New York Stock Exchange

SEC:

Securities Exchange Commission

SRO:

Rules Refers collectively to the 2002 amendments to the Rules of the NASD and NYSE

References

  • Agrawal, A., & Chen, M. A. (2008). Do analyst conflicts matter? Evidence from stock recommendations. Journal of Law and Economics, 51(3), 503–537.

    Article  Google Scholar 

  • Agrawal, A., & Chen, M. A. (2012). Analyst conflicts and research quality. Quarterly Journal of Finance, 02(02), 179–218.

    Article  Google Scholar 

  • Ali, A. (1996). Bias in analysts’ earnings forecasts as an explanation for the long-run underperformance of stocks following equity offerings. Working Paper. University of Texas, Dallas.

  • Becher, D. A., Cohn, J. B., & Juergens, J. L. (2015). Do stock analysts influence merger completion? An examination of postmerger announcement recommendations. Management Science (Forthcoming).

  • Clement, M. B. (1999). Analyst forecast accuracy: Do ability, resources, and portfolio complexity matter? Journal of Accounting and Economics, 27(3), 285–303.

    Article  Google Scholar 

  • Cowen, A., Groysberg, B., & Healy, P. (2006). Which types of analyst firms are more optimistic? Journal of Accounting and Economics, 41(1–2), 119–146.

    Article  Google Scholar 

  • Jackson, A. R. (2005). Trade generation, reputation, and sell-side analysts. The Journal of Finance, 60(2), 673–717.

    Article  Google Scholar 

  • Jacob, J., Lys, T. Z., & Neale, M. A. (1999). Expertise in forecasting performance of security analysts. Journal of Accounting and Economics, 28(1), 51–82.

    Article  Google Scholar 

  • Jarnecic, E., & Pham, N. Y. (2012). The impact of M&A advisor affiliation on analyst research and broker market share. Working Paper. University of Sydney, Sydney.

  • Kadan, O., Madureira, L., Wang, R., & Zach, T. (2009). Conflicts of interest and stock recommendations: The effects of the global settlement and related regulations. Review of Financial Studies, 22(10), 4189–4217.

    Article  Google Scholar 

  • Kolasinski, A. C., & Kothari, S. P. (2008). Investment banking and analyst objectivity: Evidence from analysts affiliated with mergers and acquisitions advisors. Journal of Financial and Quantitative Analysis, 43(04), 817–842.

    Article  Google Scholar 

  • Lin, H., & McNichols, M. F. (1998). Underwriting relationships, analysts’ earnings forecasts and investment recommendations. Journal of Accounting and Economics, 25(1), 101–127.

    Article  Google Scholar 

  • Ljungqvist, A., Marston, F., & Wilhelm, W. J. (2006). Competing for securities underwriting mandates: Banking relationships and analyst recommendations. The Journal of Finance, 61(1), 301–340.

    Article  Google Scholar 

  • Malmendier, U., & Shanthikumar, D. (2007). Are small investors naive about incentives? Journal of Financial Economics, 85(2), 457–489.

    Article  Google Scholar 

  • Michaely, R., & Womack, K. L. (1999). Conflict of interest and the credibility of underwriter analyst recommendations. Review of Financial Studies, 12(4), 653–686.

    Article  Google Scholar 

  • Mikhail, M. B., Walther, B. R., & Willis, R. H. (1997). Do security analysts improve their performance with experience? Journal of Accounting Research, 35, 131–157.

    Article  Google Scholar 

  • National Association of Securities Dealers (NASD). (2002). Rule 2711. Research analysts and research reports. Available at: http://finra.complinet.com/en/display/display_main.html?rbid=2403&element_id=3675. Accessed 28 Jan 2015.

  • New York Attorney General Affidavit. (2002), Affidavit in support of an application for an order pursuant to general business law section 354, Spitzer–Petitioner (eds.). Available at: http://www.ag.ny.gov/sites/default/files/press-releases/archived/MerrillL.pdf. Accessed 28 Jan 2015.

  • New York Stock Exchange (NYSE). (2002). Rule 472: Communications with the public. Available at: http://nyserules.nyse.com/NYSETools/PlatformViewer.asp?selectednode=chp_1_5_12_3&manual=%2Fnyse%2Frules%2Fnyse-rules%2F. Accessed 15 Jan 2015.

  • O’Brien, P. C., McNichols, M. F., & Lin, H. (2005). Analyst impartiality and investment banking relationships. Journal of Accounting Research, 43(4), 623–650.

    Article  Google Scholar 

  • Palazzo, G., & Rethel, L. (2008). Conflicts of interest in financial intermediation. Journal of Business Ethics, 81(1), 193–207.

    Article  Google Scholar 

  • Petersen, M. A. (2009). Estimating standard errors in finance panel data sets: Comparing approaches. The Review of Financial Studies, 22(1), 435–480.

    Article  Google Scholar 

  • Securities Exchange Commission. (2003). Global settlement fact sheet. Available at: http://www.sec.gov/news/speech/factsheet.htm. Accessed 7 Jan 2015.

  • United States Government Accountability Office (GAO). (2012). Securities research. Additional actions could improve regulatory oversight of analyst conflicts of interest. Available at: http://www.gao.gov/products/GAO-12-209. Accessed 7 Jan 2015.

  • Veit, E. T., & Murphy, M. (1996). Ethics violations: A survey of investment analysts. Journal of Business Ethics, 15(12), 1287–1297.

    Article  Google Scholar 

Download references

Acknowledgments

Our paper has benefited from feedback provided by Tracy Wang, Millicent Chang, and participants at the 2015 AFAANZ Annual Conference, Hobart. We gratefully acknowledge this feedback, and acknowledge suggestions provided by an anonymous reviewer and the Section Editor, Gary Monroe.

Author information

Authors and Affiliations

  1. Research School of Accounting, College of Business and Economics, Australian National University, Canberra, Australia

    Minzhi Wu & Mark Wilson

  2. Discipline of Accounting, University of Sydney Business School, University of Sydney, Sydney, Australia

    Yi Wu

Authors
  1. Minzhi Wu
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Mark Wilson
    View author publications

    You can also search for this author in PubMed Google Scholar

  3. Yi Wu
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Mark Wilson.

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Wu, M., Wilson, M. & Wu, Y. Was the Global Settlement Effective in Mitigating Systematic Bias in Affiliated Analyst Recommendations?. J Bus Ethics 146, 485–503 (2017). https://doi.org/10.1007/s10551-015-2888-6

Download citation

  • Received:

  • Accepted:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10551-015-2888-6

Keywords

Search

Navigation