Talking Down the Competition: How Financial Analysts Influence Market Perception

Why It Matters

Financial analysts play a key role in shaping investor perceptions. This research uncovers that financial analysts issue pessimistic forecasts for competitors of their investment banking clients, influencing market dynamics in unexpected ways.

Key Takeaways

• Analysts issue more negative forecasts for competitors of their investment banking clients than for unrelated firms.

• This bias is stronger when the client is more important to analysts’ brokerage houses, when high uncertainty prevents competitors from detecting analysts’ strategic motives, and when analysts’ brokerage houses are less prestigious.

• The findings highlight potential conflicts of interest in financial forecasting, with implications for companies, investors, and regulators.

How Analysts Influence Competitor Perception

Financial analysts provide critical insights into company performance, often influencing stock prices and investor decisions. Prior research shows that analysts tend to issue optimistic forecasts for companies with whom they have investment banking relationships. This study reveals another dimension: issuing pessimistic forecasts for those clients’ competitors.

The logic behind this behaviour is simple — analysts aim to please their clients by shaping the market in their favour. A negative forecast about a competitor can lower its perceived profitability, operating efficiency, and future growth potential, indirectly benefiting the client. However, this presents a dilemma: while issuing negative forecasts might satisfy the client, it risks damaging relationships with the competitor’s management, potentially limiting access to future information.

Key Findings from the Study

The researchers analysed 385,467 annual earnings per share (EPS) forecasts issued by 9,357 analysts for 5,112 firms from 1994 to 2018. Their findings reveal a clear pattern: analysts issued 11.2% more pessimistic forecasts for their clients’ competitors than for unrelated firms.

They conduct cross-sectional analyses to provide insights into the factors that influence analysts' behaviours and offer further evidence that is consistent with their central hypothesis.

• Importance of clients: They first focus on the importance of the client firm to the analyst’s brokerage house. They expect that analysts have stronger incentives to please a more important client, implying a higher incentive to issue pessimistic forecasts for the client’s competitors. They gauge importance through the size of the investment banking deals with the client, computed as the ratio of the total dollar value of all deals between the client and the broker over the past three years to the total dollar value of all deals made by the broker in the same period. The results show that for a less important client, the pessimism associated with the client’s competitor is only 41.5% of that for a more important client.

   

• High uncertainty: The researchers expect that the tendency to issue pessimistic opinions about the client’s competitors is more pronounced when there is higher uncertainty about the future prospects of the competitor. The cost of issuing pessimistic forecasts for the competitor lies in the displeasure of the competitor’s management. The management is less likely to detect the analyst’s strategic incentive and subsequently penalise the analyst if there exists substantial uncertainty about the firm’s future. Therefore, the lower expected cost motivates the analysts to engage in such behavior. They test this prediction by using forecast dispersion and earnings volatility as measures of uncertainty. The pessimism for competitors with low forecast dispersion (earnings volatility) is only 34.9% (29.1%) of that for competitors with high forecast dispersion (earnings volatility). The results support the notion that analysts deem uncertainty to be a viable cover for what may be intentional pessimism.

   

• Reputation of investment banks: Lastly, prior studies suggest that the investment bank’s reputation serves as a signal of the client’s quality (Carter et al., 1998; Jo et al., 2007). Therefore, the researchers expect that more prestigious investment banks are in greater demand, and they have lower incentives to please the client by issuing pessimistic forecasts for the client’s competitors. The results support this prediction. Specifically, pessimism for clients’ competitors is reduced by 84.5% if the forecasts are issued by analysts from a more reputable investment bank, compared to those from a less reputable one.
  

Business Implications

These findings have major implications for companies, regulators, and investors alike:

• For Companies: If your business competes with firms that have strong investment banking ties, be aware that analyst forecasts may not be entirely objective. Understanding potential biases in market forecasts can help businesses navigate investor sentiment more effectively.
• For Policymakers: The study raises concerns about conflicts of interest in financial analysis. Regulators may need to introduce more transparency and oversight to prevent analysts from unfairly influencing competitor valuations.
• For Investors: Analysts' forecasts are often viewed as objective indicators of a company’s health. However, this study suggests that investors should critically evaluate financial reports, particularly when they concern a client’s direct competitors.

Authors & Sources 

Authors: Fangbo Si (Jinan University), Xiaoxu Xu (Central University of Finance and Economics), and Huai Zhang (Nanyang Technological University). Both Fangbo and Xiaoxu are formal doctoral students at Nanyang Business School, Nanyang Technological University.

Article Link: http://doi.org/10.1111/1911-3846.13018