Investment Banking Relationships Research Articles

Local versus foreign analysts' forecast accuracy: does herding matter?

The aim of this paper is to compare the information and resource endowments possessed by different analyst types, classified by both location and employment within the context of seven emerging Asian markets. Our results show that local analysts are more accurate than expatriate and global analysts when we consider all earnings forecasts. However, when we control for the segregated herding behaviour of analysts, we find that herding local forecasts are one of the least accurate compared to other herding forecasts. By contrast, bold local (that is, non‐herding local) forecasts are more accurate than all other bold forecasts. This suggests that the information endowment of bold local analysts is superior to the information and resource endowments of bold expatriate analysts. We show that the superior accuracy of bold local forecasts does not stem from business group affiliations, investment banking relationships, demand for local analysts’ services or the specialisation of analysts vis‐à‐vis countries or sectors. We consistently find that bold local analysts are better at assessing the earnings of the firm they forecast. Our results show that the prior documented advantage of local analysts in terms of forecasting accuracy is driven by the bold local analysts, with herding locals diluting this effect. To the best of our knowledge, this is the first study to explore the segregated herding behaviour of local, expatriate and global analysts, and its impact on relative forecast accuracy across analyst types.

The role of investor protections on the value of investment banking relationships: International evidence

This paper examines the role of country-level investor protections on the value of relationships between investment banks (IBs) and their corporate clients. Using an event-study approach and an international sample of consolidation activities in the investment banking industry, we document that clients of target IBs acquired by banks from stronger (weaker) investor protection countries realize lower (higher) returns upon merger announcement. This is consistent with a substitution effect between country-level investor protections and IB-level monitoring of client firms. Overall, our analysis highlights the economic role of country-level investor protections on the relationships between IBs and client firms in an international context.

Investment-Banking Relationships: 1933–2007

We study the evolution of investment bank relationships with issuers from 1933-2007. The degree to which issuers conditioned upon prior relationship strength when selecting an investment bank declined steadily after the 1960s. The issuer's probability of selecting a bank with strong relationships with its competitors also declined after the 1970s. In contrast, issuers have placed an increasing emphasis upon the quantity and the quality of their investment bank's connections with other banks. We relate the structural changes in bank/client relationships beginning in the 1970s to technological changes that altered the institutional constraints under which security issuance occurs.

Investment banking relationships and analyst affiliation bias: The impact of the global settlement on sanctioned and non-sanctioned banks

We examine the impact of the Global Settlement on affiliation bias in analyst recommendations. Using a broad measure of investment bank-firm relationships, we find a substantial reduction in analyst affiliation bias following the settlement for sanctioned banks. In contrast, we find strong evidence of bias both before and after the settlement for affiliated analysts at non-sanctioned banks. Our results suggest that the settlement led to an increase in the expected costs of issuing biased coverage at sanctioned banks, while concurrent self-regulatory organization rule changes were largely ineffective at reducing the influence of investment banking on analyst research at large non-sanctioned banks.

Do Business Relationships Affect the Accuracy of Analyst Earnings Forecasts? Evidence from China

AbstractSupporting the “conflicts of interest hypothesis,” we show that, in China, better‐informed analysts issue more optimistically biased forecasts and the reputation of financial analysts mitigates the bias. We contribute to the literature by showing that such an adverse information effect varies over types of investment banking relationships and a better developed local legal environment reduces forecast bias. Our results call for a better developed market mechanism to discipline analysts so as to issue independent and accurate earnings forecasts in China.

Morgan Stanley Group, Inc.: Initial Public Offering

This case involves the analysis of the price at which Morgan Stanley proposes initially to offer its shares. The required analysis includes various valuation techniques, as well as the qualitative assessment of strategic and environmental factors. A student Lotus worksheet file is available on computer diskette for use with this case. Excerpt UVA-F-0719 MORGAN STANLEY GROUP, INC.: INITIAL PUBLIC OFFERING On February 14, 1986, the investment bank of Morgan Stanley & Co. issued a preliminary prospectus for the sale of 4,500,000 shares of its own common stock to the public at a price estimated to be between $ 42 and $ 46 per share. This move signaled a new era in the firm's history, as previously Morgan Stanley had been organized as a “partnership” consisting of 111 managing directors and 143 principals. The offering raised numerous questions: Why had Morgan Stanley chosen to go public rather than sell to a large and well-capitalized buyer? Why did Morgan Stanley need external capital at all? Securities Industry Morgan Stanley competed with an array of firms providing underwriting, financial advice, distribution, and trading/market-making functions. Exhibit 1 provides general financial information on major domestic investment banks but, in addition, Morgan Stanley regarded itself as an international securities firm and included in its realm of competitors merchant banks (for example: S. G. Warburg & Co.), universal banks (for example: Deutschebank), the London investment banking subsidiaries of U.S. money center banks, and large Japanese financial services firms (for example: Nomura Securities). Several trends were changing the competitive structure of the securities industry. Exhibit 2 suggests the magnitude and avenues of change. The trends included increasing concentration of competition, technological change in information support systems, rising demand for a highly specialized work force, innovation in the design of financial securities, the advent of globalized trading and underwriting, inter-market trading (for example: between futures, options, and stocks), and quasi-merchant banking activities. Of special significance was the introduction of Rule 415 in 1982, which allowed corporations to keep registration statements “on the shelf” and quickly (i.e., in two days) issue securities. This rule was credited with eroding investment banking relationships and motivating issuers to seek bids for underwriting business. More recently, investment bankers had begun to bid for the entire underwriting issue in “bought deals” that were then sold directly to investors and distributed to other firms. The new levels of competition in underwriting required more capital. . . .

Investment Banking Relationships and Analyst Affiliation Bias: The Impact of Global Settlement on Sanctioned and Non-Sanctioned Banks

We examine the impact of the Global Settlement on affiliation bias in analyst recommendations. Using a broad measure of investment bank-firm relationships, we find a substantial reduction in analyst affiliation bias following the settlement for sanctioned banks. In contrast, we find strong evidence of bias both before and after the settlement for affiliated analysts at non-sanctioned banks. Our results suggest that the settlement led to an increase in the expected costs of issuing biased coverage at sanctioned banks, while concurrent SRO rule changes were largely ineffective at reducing the influence of investing banking on analyst research at large non-sanctioned banks.

Real Effects of Investment Banking Relationships: Evidence from the Financial Crisis

In this paper, we investigate the damage to real-sector investment spending and corporate financing activities triggered by the failure of three major investment banks during the 2007-09 financial crisis. We find that firms characterized by pre-crisis corporate investment banking relationships with troubled investment banks exhibit significantly lower post-crisis investment spending activity and securities issuance compared to corporations that were not affiliated with the troubled institutions. The effect varies systematically with the nature and strength of the investment banking relationship. Our results are robust with respect to various modifications and extensions of our empirical design and generally inconsistent with alternative explanations unrelated to investment banking relationships.

The Changing Nature of Investment Banking Relationships

We examine relationships between firms and their investment banks (IBs), both within and across different IB functions. For all transaction types, we find an increase in the number of relationships and a decrease in relationship exclusivity over time. We identify significant transaction-type specific relationship components, with relationships being strongest for equity and weakest for M&A. Relationships are less exclusive for firms with more bargaining power and more exclusive for younger, smaller firms, and firms with more growth options. Most importantly, we find strong evidence of a firm-wide relationship component that spans the functional areas of I-banking and increases over time.

The Value of Investment Banking Relationships: Evidence from the Collapse of Lehman Brothers

ABSTRACTWe examine the long‐standing question of whether firms derive value from investment bank relationships by studying how the Lehman collapse affected industrial firms that received underwriting, advisory, analyst, and market‐making services from Lehman. Equity underwriting clients experienced an abnormal return of around −5%, on average, in the 7 days surrounding Lehman's bankruptcy, amounting to $23 billion in aggregate risk‐adjusted losses. Losses were especially severe for companies that had stronger and broader security underwriting relationships with Lehman or were smaller, younger, and more financially constrained. Other client groups were not adversely affected.

The Value of Investment Banking Relationships: Evidence from the Collapse of Lehman Brothers

We examine the long-standing question of whether firms derive value from investment bank relationships by studying how the Lehman collapse affected industrial firms that received underwriting, advisory, analyst, and market-making services from Lehman. Equity underwriting clients experienced an abnormal return of around -5%, on average, in the seven days surrounding Lehman’s bankruptcy, amounting to $23 billion in aggregate, risk-adjusted losses. Losses were especially severe for companies that had stronger and broader security underwriting relationships with Lehman or were smaller, younger, and more financially constrained. Other client groups were not adversely affected.

Behavioural Bias and Conflicts of Interest in Analyst Stock Recommendations

Abstract: This paper tests whether sell‐side analysts are prone to behavioural errors when making stock recommendations as well as the impact of investment banking relationships on their judgments. In particular, we analyse their report narratives for evidence of cognitive bias. We find first that new buy recommendations on average have no investment value whereas new sell recommendations do, and take time to be assimilated by the market. We also show that new buy recommendations are distinguished from new sells both by the level of analyst optimism and representativeness bias as well as with increased conflicts of interest. Successful new buy recommendations are characterised by lower prior returns, value stock status, smaller firms and weaker investment banking relationships. On the other hand, successful new sells do not differ from their unsuccessful counterparts in terms of these measures. As such, we provide evidence that analysts are prone both to behavioural bias as well as potential conflicts of interest in their new buy stock recommendation decisions. We also show that these two explanations of analyst behaviour are to a great extent independent of each other. Consequently, the recent attempts by regulators to address potential conflicts of interest in analyst behaviour may have only limited impact.

Investment Banking Relationships and Merger Fees

This paper is among the first to investigate the effect of a prior investment banking relationship on merger advisory fees paid by acquiring firms. We find that acquiring firms pay a higher fee to advisors when they have had a continuing relationship and a lower fee when they switch to an advisor with whom they have had no prior relationship. We develop a measure of relationship strength between an acquiring firm and its merger advisor based on previous debt, equity and merger transactions completed by the acquiring firm. We also examine the relationship between a merger advisor s reputation and its ability to retain clients. We find that firms are more likely to switch if their M and A advisor is not a top tier investment bank. To test if higher fees are compensation for better performance, we examine differences between the average announcement returns of acquiring firms that switch advisors and those that do not. We find no significant difference between these two return samples. Overall, our findings indicate that acquiring firms perceive benefits of retaining merger advisors with whom they have had a prior relationship (even at the cost of higher fees) and/or they face some other (higher) costs of switching to new bank advisors.

Conflicts of Interest and Mutual Fund Performance: Evidence from Investment Banking Relationships

This paper examines the effect of conflicts of interest on the performance of investment bank affiliated mutual funds. We find robust evidence that affiliated funds underperform unaffiliated funds. An important source of this underperformance is the disproportionately large holdings of investment banking clients' stocks by affiliated mutual funds. The average holding of client stocks by affiliated funds is more than twice as large as their average holding of non-client stocks. More importantly, the client holdings of affiliated funds underperform both their benchmarks and non-client holdings, consistent with the long-run underperformance of equity issuers and acquirers documented in prior literature. The underperformance of affiliated funds cannot be explained by lack of investor monitoring for fund performance, nor is it mitigated by investment bank reputation. Our results are consistent with the idea that investment banks use affiliated funds as a tool to support underwriting and advising business at the expense of fund shareholders.

Conflicts of interest in sell-side research and the moderating role of institutional investors

Because sell-side analysts are dependent on institutional investors for performance ratings and trading commissions, we argue that analysts are less likely to succumb to investment banking or brokerage pressure in stocks highly visible to institutional investors. Examining a comprehensive sample of analyst recommendations over the 1994–2000 period, we find that analysts’ recommendations relative to consensus are positively associated with investment banking relationships and brokerage pressure but negatively associated with the presence of institutional investor owners. The presence of institutional investors is also associated with more accurate earnings forecasts and more timely re-ratings following severe share price falls.

Do brokerage houses add value? The market impact of UK sell-side analyst recommendation changes

This paper reports on the first full study investigating the economic role of sell-side analysts’ stock recommendations in the UK market. We also explore whether UK analysts are, in practice, influenced by the same biases as that reported for their US counterparts. We find that share prices are significantly influenced by analysts’ recommendation changes, not only at the time of the recommendation change but also in subsequent months. The price reaction to new sell recommendations is greater than the price reaction to new buy recommendations and exhibits post-recommendation drift which is consistent with initial underreaction to bad news. Returns generated are influenced, cross-sectionally, by factors associated with a firm's information environment and analyst incentives such as size, same-sign earnings forecast revisions and recommendation changes that skip a rank. We find that UK analysts’ investment recommendations in practice appear less susceptible to potential conflicts of interest than their US counterparts. The ratio of new sell to buy recommendations is higher in the UK and a greater proportion of such recommendations are accompanied by same-sign earnings forecast revisions than their equivalents in the US. We find brokerage house investment banking relationships do not appear to impact (adversely) on abnormal returns.

How Do Analyst Recommendations Respond to Major News?

AbstractWe examine how analysts respond to public information when setting stock recommendations. We model the determinants of analysts' recommendation changes following large stock price movements. We find evidence of an asymmetry following large positive and negative returns. Following large stock price increases, analysts are equally likely to upgrade or downgrade. Following large stock price declines, analysts are more likely to downgrade. This asymmetry exists after accounting for investment banking relationships and herding behavior. This result suggests recommendation changes are “sticky” in one direction, with analysts reluctant to downgrade. Moreover, this result implies that analysts' optimistic bias may vary through time.

Competing for Securities Underwriting Mandates: Banking Relationships and Analyst Recommendations

ABSTRACTWe investigate whether analyst behavior influenced banks' likelihood of winning underwriting mandates for a sample of 16,625 U.S. debt and equity offerings in 1993–2002. We control for the strength of the issuer's investment banking relationships with potential competitors for the mandate, prior lending relationships, and the endogeneity of analyst behavior and the bank's decision to provide analyst coverage. Although analyst behavior was influenced by economic incentives, we find no evidence that aggressive analyst behavior increased their bank's probability of winning an underwriting mandate. The main determinant of the lead‐bank choice is the strength of prior underwriting and lending relationships.

The Impact of All-star Analyst Job Changes on Their Coverage Choices and Subsequent Investment Banking Deal Flow

Using a sample of all-star analysts who switch investment banks between 1988 and 1999, we examine (1) whether analyst behavior is influenced by investment banking relationships and (2) whether analyst behavior affects investment banking deal flow (debt and equity underwriting and corporate control transactions). Although the stock coverage decision is dependent on the investment banking relationship with the client firms, we find no evidence that analysts change their optimism or recommendation levels when joining a new firm. Investment banking deal flow is related to analyst reputation only for equity underwriting transactions. For debt underwriting and M&A transactions, after controlling for bank reputation, analyst reputation does not matter. There is no evidence that issuing optimistic earnings forecasts or recommendations affects investment banking deal flow.

Are Affiliated Analysts More Likely than Unaffiliated Analysts to Provide Eps Forecasts that Management Can Meet or Beat?

We examine analysts' incentive to avoid negative earnings surprises by testing the effect of investment banking relationships on analysts' tendency to issue EPS forecasts that management ultimately can meet or beat. Using 19,014 sample firm-quarters for the 1991-2002 period, we find that firms meet or exceed affiliated analysts' EPS forecasts 6% more often than unaffiliated analysts' EPS forecasts. This tendency is more pronounced for firms with a strong investment bank relationship and firms with a limited ability to manage earnings. We further report that affiliated analysts with achievable forecasts generate future investment banking business, but do not improve their future forecast accuracy. We also find some evidence that management could gain from affiliated analysts' achievable EPS forecasts because of their influence on unaffiliated analysts' forecast revisions. Collectively, these findings support the view that analysts whose employers maintain close ties to a firm keep their EPS forecasts at an achievable level to obtain future investment banking business.