Political Cycles and Analyst Bias

Abstract

We examine the role that political-economic factors play in shaping financial analyst bias using a series of scheduled provincial elections in China. Theory on political business cycles holds that, in a short period prior to these political events, provincial politicians have stronger incentives to bias analyst opinions toward optimism. Consistent with this intuition, we document that analysts are significantly more likely to issue favorable recommendations or revise their recommendations upward during political event periods. In cross-sectional evidence consistent with expectations, we find that the relation between political events and analyst optimism is more pronounced for analysts: covering local state-controlled companies, working for brokerage firms affiliated with local politicians, covering companies in provinces with more potential investment banking business, and working for brokerage firms with less valuable reputations to protect. Supporting that foreign analysts are more immune to local political forces, we find that their recommendations do not become more optimistically biased during political event periods. Analyzing stock returns upon and subsequent to the release of favorable recommendations issued during political event periods reveal that investors perceive such recommendations as less credible, although they fail to fully discount their information value. Reinforcing our main evidence, we also find that financial analysts are more likely to issue optimistic earnings forecasts during political event periods. Collectively, our research implies that politicians successfully distort analyst incentives for political purposes.