The Reputation-Accuracy Relationship in Analyst Research

The theory presented in this paper models a dynamic interaction between reputation and underwriting pressure in analyst research. We examine how these conflicting incentives affect the analysts' forecasts strategy and how investment banks may design compensation contracts that induce their analysts to perform the conflicting tasks. First, we show that the bank will propose a full incentives contract - one that offers performance-based incentives for both tasks - when reputation is above a threshold level and a partial incentives contract - one that offers performance-based incentives for providing forecast quality and standard-based incentives for generating trading volume - otherwise. The model also shed light about how the quot;reputation effectquot; and the quot;underwriting pressure effectquot; interact in determining research quality. We thus show that under the full performance-based contract, first period research effort is lower than under the partial performance-based contract. This translates into a higher first period research effort for analysts working in lower status banks compared to those working at high status banks. Our results corroborate previous evidence suggesting that analysts are subject to investment banking and brokerage pressure thereby affecting their forecasts accuracy