Analystss Advice on IPOs and Regulations: An Analysis of US and European Markets

Abstract

Using recommendations and target prices on initial public offerings (IPOs), we examine the impact of regulations in the US and European Union (EU) markets that were aimed at curbing conflicts of interest in sell-side research. Conflicted analysts, proxied by whether their brokerage houses acted as lead or co-managers in the IPO process, issue more optimistic recommendations in the pre-regulatory period both in the US and EU markets, but this extra optimism is absent after the adoption of regulations. A similar pattern emerges when looking at returns implied from target prices for US IPOs. Investors seem to capture the pattern, as they discount optimistic recommendations from conflicted analysts before, but not after, the new regulations. Using the staggered implementation of the new regulations—whereby US regulations take place strictly before any of the changes in the EU markets—we show that US brokers take the new modus operandi to Europe. In the time between the passage of US regulations and EU regulations, US brokers in the lead role act in Europe similarly to the way they started acting in US. The EU brokers continued with their optimistic projections until the implementation of the local regulations.