How analyst recommendations respond to corporate uncertainty caused by investment behavior: Currying favor with management or conflicts of interest from connections

Abstract

Purpose

Corporate investment behavior increases the uncertainty of a company’s operation and performance. The purpose of this paper is to investigate how analyst recommendations respond to corporate uncertainty caused by investment behavior and what motivates analysts to react as they do.

Design/methodology/approach

The authors test two motivation hypotheses: the hypothesis that analysts are currying favor with management to obtain private information and the hypothesis that analysts have conflicts of interest due to connections. Using Chinese analyst-level data from 2007 to 2015, the authors find that overall investment levels, R&D investment and M&A events are significantly positively correlated with analyst recommendations, suggesting that analysts tend to react optimistically to corporate investment behavior.

Findings

Analysts are only optimistic about companies with low information transparency, suggesting that analysts may be trying to curry favor with management to gain access to private information. The authors find that analysts with stronger recommendations have more private information and analysts with more private information publish more accurate earnings forecasts, which supports the hypothesis that analysts curry favor with management through optimistic recommendations to obtain more private information. This is consistent with the logic that the difficulty of earnings forecasting increases under uncertain conditions, increasing the demand for private information. The authors then group the analysts according to their underwriting connections, securities company’s proprietary connections and fund connections, and find that the positive correlation between corporate investment behavior and analyst recommendations exists only in the unconnected groups. This is evidence against the hypothesis that analysts have conflicts of interest due to their connections.

Originality/value

First, the authors link the optimism of analysts with the uncertainty of analysts’ information inputs to partially unpack the black box of analysts’ analyses. Second, the authors test the two hypotheses mentioned. There is a lack of comparative studies on the influence of different motivations on the behavior of analysts.

Citation

Zhang, L. and Wei, M. (2020), "How analyst recommendations respond to corporate uncertainty caused by investment behavior: Currying favor with management or conflicts of interest from connections", China Finance Review International, Vol. 10 No. 3, pp. 243-269. https://doi.org/10.1108/CFRI-05-2019-0046