Analysts' optimism brings rewards
Harrison Hong, an associate professor at Stanford, with Jeffrey Kubik, assistant professor of economics at Syracuse University in New York, point out that there are three possible explanations for biased stock recommendations.
The first is career concern, where analysts are rewarded for their optimism. The second is selection bias, where analysts tend to cover stocks they can recommend over ones they cannot. Third is cognitive/behavioural bias, where analysts tend to like the stocks they cover.
Although brokerage houses have been forced to tighten practices, Hong says firms have had reward systems in place - more implicit than explicit - as long as bullish comments were within a range of accuracy that maintained analysts' credibility. Analysts who issued favourable notes had a better chance of gaining promotion or being poached by higher-rated firms.
Hong and Kubik compared employment and earnings forecast histories of around 12,000 analysts working for 600 brokerage houses between 1983 and 2000. They note that while analysts' careers depended on accuracy, it was not the only factor in their advancement. A positive outlook also helped.
They found that analysts who were extremely inaccurate were about 62% more likely to experience a downward move, while those who were extremely accurate were roughly 52% inclined to rise through the ranks.
However, analysts who issued a large fraction of optimistic forecasts were about 38% less likely to move down the brokerage house ladder and approximately 90% more likely to ascend.
