Paying for Coverage: Conflict of Interest Among Company-Sponsored Research Firms

Abstract

The Securities and Exchange Commission has recommended company-sponsored research to address the need for greater analyst following of smaller companies. Anecdotal evidence suggests company-sponsored research is more optimistic than research from traditional brokerage firms (Kalra 2004; Lee and Metaxas 2004; Richardson 2006). Using a sample of companies with both company-sponsored analysts and traditional analysts, I find that analysts at company-sponsored research firms are more likely to issue positive recommendations than analysts at traditional brokerage firms. Further, while the market reacts to recommendation announcements of traditional analysts, I fail to find a significant market reaction to recommendation announcements of company-sponsored analysts. Interestingly, however, I find significant positive (negative) post-announcement abnormal returns following Strong Buy (Sell) recommendation announcements of company-sponsored analysts. Similar results are observed following traditional analyst Strong Buy recommendations, but I do not find significant negative abnormal returns following their Sell recommendations. These results suggest that the market fails to fully appreciate the information contained in the announcement of company-sponsored and traditional analysts' Strong Buy recommendations, while uniquely failing to appreciate the information contained in company-sponsored analyst Sell recommendations.