Sell-side analysts who are on the brink of moving to the buy side are more likely to write favorable research about companies that are important to their future employer, according to a recent academic study.
In the year before moving from sell-side research to buy-side research, analysts write more favorably about the stocks their future employer has large positions in and that the analyst can have a greater impact on, such as small-cap companies and stocks with low analyst coverage, according to analysis by Biwen Zhang, assistant professor in the accounting group at UC Berkeley’s Haas School of Business.
This effect is most pronounced if the analyst moves from the sell side to a venture capital/private equity firm or to a hedge fund, Zhang finds.
‘A transition-seeking analyst is more incentivized to issue favorable reports on these stocks, when compared with other stocks held by the same institution,’ Zhang writes. ‘Thus, if a transition-seeking analyst strategically caters to buy-side institutions by issuing favorable reports on stocks heavily held by those institutions, I expect such favoritism to be more pronounced for high-analyst-impact stocks. Consistent with this prediction, I find the favoritism effects are indeed more pronounced for small-cap stocks and stocks with low analyst coverage.’
Zhang finds that this favoritism manifests in the year before a career transition to the buy side, and only in the event the career transition is planned. She compares analysts’ price target forecasts over a four-year period and notes a significant uptick in optimism in the year prior to a career transition to the buy side. For analysts who took more than a six-month break between their time on the sell side and a move to the buy side, there is less evidence of any bias.
‘I did a lot of work to try to distinguish between conscious and unconscious behavior,’ Zhang tells IR Magazine. ‘I find that the favoritism is time-specific: it’s only there for the year before [a career transition]. I identified a group of analysts who are less likely to have a strategically planned transition – those with a transition gap. What I find is that the favoritism is greater when the transition is planned.’
To test the veracity of her findings, Zhang also examined whether the favoritism she identified could be attributed to the entire sell-side firm the analyst worked at before moving, a situation she calls ‘the broker effect’.
She finds some evidence that sell-side firms wrote more favorable research about stocks that their more important clients have large holdings in, but the favoritism is much more pronounced at the individual analyst level.
‘We expect analysts to move to institutional clients, rather than non-clients,’ Zhang tells IR Magazine. ‘The broker effect studies the behavior of the brokerage as a whole, whereas the career effect is analyst-specific. I find that colleagues exhibit some level of favoritism [toward their large clients], but that the impact is much, much smaller.’Â
Study design
Zhang gathered data for analysts who wrote at least one recommendation on a US firm between 1993 and 2015. She then searched online CV databases – most notably LinkedIn – to identify individuals’ career moves. Finally, she cross-referenced this information with Thomson Reuters’ 13F database to confirm that the sell-side analysts did indeed end up on the buy side. Ultimately, her findings cover 768 analysts’ career moves.
Zhang tells IR Magazine that she is unable to parse the data into groupings before and after Regulation Fair Disclosure, which heavily regulated the relationship between the buy side and the sell side when it came into force in the year 2000.
While Zhang’s research encompasses career data that pre-dates Mifid II and is focused on US-based analysts, she notes in her report that the EU regulation has prompted greater movement of analysts from the sell side to the buy side.
