Measure for Measure : The Relation between Forecast Accuracy and Recommendation Profitability of Analysts

We examine the relation between earnings forecast accuracy and recommendation profitability to assess the effectiveness with which analysts translate forecasts into profitable recommendations. We find that after controlling for expertise, more accurate analysts make more profitable recommendations, albeit only for firms with value-relevant earnings. Next, we show that conflicts of interest from investment banking activities affect the relation between accuracy and profitability. In case of Buy recommendations, more accurate forecasts result in more profitable recommendations only for the non-conflicted analysts. For Hold recommendations, profitability is increasing in accuracy for conflicted analysts, provided these recommendations are treated as Sells. Finally, we find that regulatory reforms aimed at mitigating analyst conflicts of interest appear to have improved the relation between accuracy and profitability. Specifically, the integrity of Buy and Hold recommendations has improved and the change is more pronounced for analysts expected to be most conflicted