Optimism bias in financial analysts earnings forecasts: do - PowerPoint PPT Presentation

Conflicts of interests in finance : the example of earnings forecasts The goal of CSA regulation : reduce analysts’ optimism Data and method Results Discussion Optimism bias in financial analysts’ earnings forecasts: do Commission sharing agreements reduce conflicts of interest? Sébastien Galanti 1 Anne-Gaël Vaubourg 2 1 Univ. Orléans, LEO, France 2 Univ. Bordeaux, LAREFI, France GdRE 2016 Clermont-Ferrand, 6-7 July 2016 Université d’Auvergne, CERDI S. Galanti and A-G Vaubourg Commission Sharing Agreements (CSA)

Conflicts of interests in finance : the example of earnings forecasts The goal of CSA regulation : reduce analysts’ optimism Data and method Results Discussion Outline Conflicts of interests in finance : the example of earnings 1 forecasts The goal of CSA regulation : reduce analysts’ optimism 2 Data and method 3 Results 4 Discussion 5 S. Galanti and A-G Vaubourg Commission Sharing Agreements (CSA)

Conflicts of interests in finance : the example of earnings forecasts The goal of CSA regulation : reduce analysts’ optimism Conflict of interest : trading commission incentive Data and method Literature on optimistic earnings forecasts Results Literature on regulation Discussion Conflicts of interest : trading commission incentive Conflicts of interest in finance S. Galanti and A-G Vaubourg Commission Sharing Agreements (CSA)

Conflicts of interests in finance : the example of earnings forecasts The goal of CSA regulation : reduce analysts’ optimism Conflict of interest : trading commission incentive Data and method Literature on optimistic earnings forecasts Results Literature on regulation Discussion Conflicts of interest : trading commission incentive Conflicts of interest in finance When an agent faces conflicting incentives S. Galanti and A-G Vaubourg Commission Sharing Agreements (CSA)

Conflicts of interests in finance : the example of earnings forecasts The goal of CSA regulation : reduce analysts’ optimism Conflict of interest : trading commission incentive Data and method Literature on optimistic earnings forecasts Results Literature on regulation Discussion Conflicts of interest : trading commission incentive Conflicts of interest in finance When an agent faces conflicting incentives Achieving objective A prevents achieving objective B S. Galanti and A-G Vaubourg Commission Sharing Agreements (CSA)

Conflicts of interests in finance : the example of earnings forecasts The goal of CSA regulation : reduce analysts’ optimism Conflict of interest : trading commission incentive Data and method Literature on optimistic earnings forecasts Results Literature on regulation Discussion Conflicts of interest : trading commission incentive Conflicts of interest in finance When an agent faces conflicting incentives Achieving objective A prevents achieving objective B Application : "sell-side" stock analysts in brokerage houses S. Galanti and A-G Vaubourg Commission Sharing Agreements (CSA)

Conflicts of interests in finance : the example of earnings forecasts The goal of CSA regulation : reduce analysts’ optimism Conflict of interest : trading commission incentive Data and method Literature on optimistic earnings forecasts Results Literature on regulation Discussion Conflicts of interest : trading commission incentive Conflicts of interest in finance When an agent faces conflicting incentives Achieving objective A prevents achieving objective B Application : "sell-side" stock analysts in brokerage houses Broker : maximize trading commission fees S. Galanti and A-G Vaubourg Commission Sharing Agreements (CSA)

Conflicts of interests in finance : the example of earnings forecasts The goal of CSA regulation : reduce analysts’ optimism Conflict of interest : trading commission incentive Data and method Literature on optimistic earnings forecasts Results Literature on regulation Discussion Conflicts of interest : trading commission incentive Conflicts of interest in finance When an agent faces conflicting incentives Achieving objective A prevents achieving objective B Application : "sell-side" stock analysts in brokerage houses Broker : maximize trading commission fees Analyst : provide independent research to clients S. Galanti and A-G Vaubourg Commission Sharing Agreements (CSA)

Conflicts of interests in finance : the example of earnings forecasts The goal of CSA regulation : reduce analysts’ optimism Conflict of interest : trading commission incentive Data and method Literature on optimistic earnings forecasts Results Literature on regulation Discussion Conflicts of interest : trading commission incentive Conflicts of interest in finance When an agent faces conflicting incentives Achieving objective A prevents achieving objective B Application : "sell-side" stock analysts in brokerage houses Broker : maximize trading commission fees Analyst : provide independent research to clients Earnings forecast "in line" with consensus : no trade (i.e. no profit) S. Galanti and A-G Vaubourg Commission Sharing Agreements (CSA)

Conflicts of interests in finance : the example of earnings forecasts The goal of CSA regulation : reduce analysts’ optimism Conflict of interest : trading commission incentive Data and method Literature on optimistic earnings forecasts Results Literature on regulation Discussion Conflicts of interest : trading commission incentive Conflicts of interest in finance When an agent faces conflicting incentives Achieving objective A prevents achieving objective B Application : "sell-side" stock analysts in brokerage houses Broker : maximize trading commission fees Analyst : provide independent research to clients Earnings forecast "in line" with consensus : no trade (i.e. no profit) ⇒ Incentive to issue biased (optimistic) forecasts to generate trading commissions. S. Galanti and A-G Vaubourg Commission Sharing Agreements (CSA)

Conflicts of interests in finance : the example of earnings forecasts The goal of CSA regulation : reduce analysts’ optimism Conflict of interest : trading commission incentive Data and method Literature on optimistic earnings forecasts Results Literature on regulation Discussion The literature Vast literature on analysts’ accuracy and optimism (e.g. Ramnath et al. 2008). Here : commission incentive. S. Galanti and A-G Vaubourg Commission Sharing Agreements (CSA)

Conflicts of interests in finance : the example of earnings forecasts The goal of CSA regulation : reduce analysts’ optimism Conflict of interest : trading commission incentive Data and method Literature on optimistic earnings forecasts Results Literature on regulation Discussion The literature Vast literature on analysts’ accuracy and optimism (e.g. Ramnath et al. 2008). Here : commission incentive. Hayes (1998), Jackson (2005), Mehran and Stulz (2007) : optimistic analysts do generate more trading commissions for their brokerage firm S. Galanti and A-G Vaubourg Commission Sharing Agreements (CSA)

Conflicts of interests in finance : the example of earnings forecasts The goal of CSA regulation : reduce analysts’ optimism Conflict of interest : trading commission incentive Data and method Literature on optimistic earnings forecasts Results Literature on regulation Discussion The literature Vast literature on analysts’ accuracy and optimism (e.g. Ramnath et al. 2008). Here : commission incentive. Hayes (1998), Jackson (2005), Mehran and Stulz (2007) : optimistic analysts do generate more trading commissions for their brokerage firm "Optimism" or "biased forecasts" : Earnings forecasts > Realized earnings S. Galanti and A-G Vaubourg Commission Sharing Agreements (CSA)

Conflicts of interests in finance : the example of earnings forecasts The goal of CSA regulation : reduce analysts’ optimism Conflict of interest : trading commission incentive Data and method Literature on optimistic earnings forecasts Results Literature on regulation Discussion The literature Vast literature on analysts’ accuracy and optimism (e.g. Ramnath et al. 2008). Here : commission incentive. Hayes (1998), Jackson (2005), Mehran and Stulz (2007) : optimistic analysts do generate more trading commissions for their brokerage firm "Optimism" or "biased forecasts" : Earnings forecasts > Realized earnings The clients : mostly mutual funds and pension funds (cf Brown et al. 2015) : optimism can be detrimental to their wealth (De Franco, Lu and Vasvari 2007) S. Galanti and A-G Vaubourg Commission Sharing Agreements (CSA)

Conflicts of interests in finance : the example of earnings forecasts The goal of CSA regulation : reduce analysts’ optimism Conflict of interest : trading commission incentive Data and method Literature on optimistic earnings forecasts Results Literature on regulation Discussion The literature (cont’d) Many reforms attempt to curb conflicts of interest in analysts’ research (Epsahbodi et al. 2015) S. Galanti and A-G Vaubourg Commission Sharing Agreements (CSA)