Do Analysts Cater to Investor Beliefs? Evidence from Market Liberalization in China

Abstract

We examine whether financial analysts cater to investors’ beliefs, using the market liberalization (Stock Connect) programs in China as a shock to investor beliefs. We find that analysts become less optimistic in their recommendations following the introduction of less optimistic investors through the Stock Connect programs. In addition, catering theory predicts that when investors hold heterogeneous beliefs, analysts tend to segment the market and slant toward extreme positions in order to attract target investors. Consistent with this prediction, we find that analyst dispersion increases in the post period. Moreover, analysts with buy or strong buy (sell or underperform) recommendations of a given firm become more optimistic (pessimistic) in their research report tone. Finally, we show that in updating their earnings forecasts, analysts are more (less) responsive to earnings surprises that are consistent (inconsistent) with their stock recommendations. Overall, this paper presents evidence supporting a catering theory for analyst bias.