We study whether changes in analyst recommendation ratings systems encouraged by the implementation of NASD 2711 in 2002 are associated with improved objectivity and independence in analyst recommendations. Using recommendations issued during windows surrounding major investment banking events, we show that reductions in analyst optimism following the reforms concentrate in the recommendations of analysts whose employer adopted a three-tier rating system at the time of the reforms, and that this effect is generally stronger for analysts whom the underlying incentives to (...) engage in unethical behaviour is greatest. We also find evidence that adoption of the three-tier system improved the market’s perception of the objectivity of analyst recommendations issued after SEOs, and that for hold and sell-type recommendations this effect was stronger for analysts subject to the greatest potential ethical conflicts. While we find some evidence of a general post-reform increase in the profitability of recommendations issued following equity transactions, this improvement was only conditioned by changes to the rating system in our IPO sample. (shrink)

We investigate how a broker firm’s initial public offering affects its analysts’ fiduciary duty of providing independent and objective recommendations. We find that the analysts of newly listed broker firms issue more positively biased recommendations in the first 2 to 3 years after their employers’ IPO than before the IPO. The increase in the recommendation bias is greater among analysts of affiliated brokers and brokers that raise additional capital after their IPO than among other analysts. Newly listed broker firms experience (...) significant increases in revenue and trading commission, and the increases are positively related to recommendation bias, after controlling for many other factors. More importantly, recommendation bias decreases as newly listed broker firms season and as the importance of trading commission declines. This suggests that public exposure through a broker firm’s IPO does not enhance the integrity and professional conduct of its financial analysts. Rather, economic incentives make financial analysts more accepting of unethical behavior. The overall results imply that the public trading of financial gatekeepers compromises the ethical relationship between financial service professionals and society in general. (shrink)

This paper investigates the integrity of financial analysts by examining their recommendation responses to large quarterly earnings surprises. Although there is no significant difference in recommendation changes between affiliated and unaffiliated analysts in response to positive earnings surprises, affiliated analysts are more reluctant than unaffiliated analysts to downgrade stock recommendations in response to negative earnings surprises. The evidence implies that conflicts of interest undermine the integrity of financial analysts. We further examine the effects of reputation concern and the Global Research (...) Analyst Settlement as informal and formal mechanisms, on restoring analysts’ integrity. The results show that the positive bias in recommendations remains prevalent for affiliated analysts from reputable investment banks and for the postreform period. Finally, evidence from market reactions suggests that investors fail to notice that analysts’ integrity is compromised by conflicts of interest and are misled by affiliated analysts. (shrink)

Regulators have recently relaxed some provisions of the Global Research Analyst Settlement of 2003 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 advisor for the covered firm, 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. (shrink)

The human resources profession emphasizes the personal and interpersonal aspects of work, that make it conscious of complex ethical issues in relationships in the workplace, while finance specialists are conversant with routine compliance with regulations. Marketing professionals are under pressure to produce revenue results. Thus, this research hypothesized that human resources managers would be more disapproving of unethical conduct than both finance and marketing functional managers, and that finance managers would be more disapproving than marketing managers. When asked to evaluate (...) instances of unethical behavior in vignettes, human resources and finance managers were both significantly more disapproving than marketing managers. However, human resources managers were not significantly more disapproving than finance managers. Explanations for the results lie in the divergent antecedent conditions, objectives, perceptions of ethical problems and demands of the various functions. Alternative behavior patterns to resolve ethical dilemmas and expected consequences by the different functions also define their ethical orientations. Average responses on the disapproving side from all three functional groups are explained by two complementary trends that promote ethical awareness among all functional managers. One is the adoption of homogeneous conventions in ethical business practice. The other trend is the increase in ethical awareness specific to each of the functional professions. (shrink)

We examine whether analyst coverage influences corporate fraud in China. The fraud triangle specifies three main factors, i.e. opportunity, incentive, and rationalization. On the one hand, analysts may reduce the fraud opportunity factor through external monitoring aimed at discouraging managerial misconduct, which can moderate agency problems. On the other hand, analysts may increase the fraud incentive factor by pressurizing managers to achieve short-term performance targets, which can exacerbate agency problem. In either case, the potential influence of analysts on the fraud (...) rationalization factor may be more pronounced among firms that are more dependent on the capital market for corporate finance. Using a sample of Chinese listed firms, we show a negative association between corporate fraud propensity and analyst coverage, and that this effect is more pronounced among non-state-owned enterprises, which are more reliant on the stock market for external funding. These findings suggest that analyst coverage contributes to corporate fraud deterrence in emerging economies characterized by weak investor protection. The main policy implication is that further development of the analyst profession in emerging economies may benefit investors and strengthen business ethics. (shrink)

Prior research suggests brokers do not always act in the best interests of clients, although morally obligated to do so. We empirically investigated this issue focusing on trades executed at best execution price, before and after the introduction of electronic limit-order trading, on the London Stock Exchange. As a result of limit-order trading, the proportion of trades executed at the best execution price for the customer significantly increased. We attribute this to a sustained increase in the liquidity of stocks as (...) a result of limit-order trading, regardless of market capitalisation. We discuss the ethical implications of our findings and conclude that market structures that enhance market competitiveness may help reconcile broker and client interests. (shrink)