The Integrity of Financial Analysts: Evidence from Asymmetric Responses to Earnings Surprises

56 Pages Posted: 16 Jun 2016 Last revised: 8 Jul 2016

See all articles by Rui Lu

Rui Lu

Sun Yat-Sen University (SYSU) - Lingnan (University) College

Wenxuan Hou

University of Edinburgh - Business School; Shanghai Lixin University of Accounting and Finance

Henry R. Oppenheimer

University of Rhode Island - Area of Finance and Insurance

Ting Zhang

University of Dayton - School of Business Administration

Date Written: June 16, 2016

Abstract

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 post-reform 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.

Keywords: Integrity, analysts’ response, conflicts of interest, earnings surprises

JEL Classification: G10, G24, G02

Suggested Citation

Lu, Rui and Hou, Wenxuan and Oppenheimer, Henry R. and Zhang, Ting, The Integrity of Financial Analysts: Evidence from Asymmetric Responses to Earnings Surprises (June 16, 2016). Journal of Business Ethics, 2016, Available at SSRN: https://ssrn.com/abstract=2796408

Rui Lu

Sun Yat-Sen University (SYSU) - Lingnan (University) College ( email )

135 Xingang Xi Road
Guangzhou, Guangdong 510275
China

Wenxuan Hou (Contact Author)

University of Edinburgh - Business School ( email )

University of Edinburgh
29 Buccleuch Place
Edinburgh, Scotland EH8 9JS
United Kingdom

HOME PAGE: http://www.wenxuanhou.com

Shanghai Lixin University of Accounting and Finance ( email )

Henry R. Oppenheimer

University of Rhode Island - Area of Finance and Insurance ( email )

Callentine Hall
7 Lippitt Road
Kingston, RI 02881-0802
United States

Ting Zhang

University of Dayton - School of Business Administration ( email )

300 College Park
Dayton, OH 45469
United States

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