Ability, conflicts of interest, and the profitability of stock recommendations for IPOs
Xia Chen
University of Chicago
Abstract: This paper studies the impact of financial analystsÂ’ ability and conflicts of interest on the profitability of buy recommendations issued for IPO companies. Based on 8,956 buy recommendations issued within one year of the offering for 1,779 IPOs over the period 1996-2000, I find that buy recommendations issued by high ability analysts without conflicts of interest consistently out-perform those by other analysts, whose buy recommendations perform similarly. This finding and additional analyses indicate that (1) high ability analysts are better at predicting future stock performance; (2) when facing conflicts of interest, high ability analysts sacrifice their predictive ability in order to promote affiliated IPOs; (3) conflicts of interest do not adversely affect low ability analystsÂ’ recommendation profitability. Further analyses suggest that both high and low ability analystsÂ’ future reputation increases with current recommendation profitability, thus reputational concerns do not drive the results.
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