EXPLORING OPTIMISM IN RECOMMENDATIONS ACCOMPANYING ANALYST CONFLICT OF INTEREST RULES

This study examines bias in recommendations following the enactment of the research analyst conflict of interest rules introduced around 2002. We label analyst recommendations as being seemingly unaffiliated when contributors are not underwriters but an acquirer or target firm of underwriters. We find that after the introduction of the rules, bias in affiliated recommendations diminishes, whereas seemingly unaffiliated recommendations reveal no signs of difference in their level of optimism. Moreover, both affiliated and seemingly unaffiliated analysts disproportionately issue unfavorable recommendations for unaffiliated firms immediately before the effective date of the rules. Our empirical evidence indicates that seemingly unaffiliated recommendations are subject to conflicts of interest. During the process of mergers and acquisitions, analysts from target firms appear to issue more optimistic recommendations than unaffiliated analysts do on their acquirer firms’ clients. After the announcement date, recommendations issued by target analysts are more optimistic than those by unaffiliated analysts despite the fact that former recommendations are relatively pessimistic before the announcement date.