The Revolving-Door of Sell-Side Analysts: A Threat to Analysts’ Independence?

Ben Lourie

University of California, Los Angeles (UCLA) – Anderson School of Management

November 13, 2014


The “revolving-door” phenomenon whereby analysts are hired by firms that they cover poses a threat to their independence. In this paper, I document this phenomenon and assess the extent to which it is associated with analysts’ issuance of biased research reports during the year prior to their employment with the covered firms. During this final year, I find that the revolving-door analysts alter their forecasts, target prices and recommendations in a direction which suggests that they are attempting to gain favor with their would-be employers. Specifically, relative to other analysts, they become more optimistic about the firms that end up hiring them while, at the same time, becoming more pessimistic about other firms’ prospects. The findings raise concerns about their independence and indicate a potential benefit to tightening employment regulations in this industry.

The Revolving-Door of Sell-Side Analysts: A Threat to Analysts’ Independence? – Introduction

In this paper, I examine whether analysts who are hired by firms they have just covered (hereafter, revolving-door analysts) bias their earnings forecasts, target prices and stock recommendations in the year prior to their move to curry favor with their would-be employers. This issue is of concern since sell-side equity analysts occupy a position of trust in the capital markets, being relied upon by the investment community to produce forecasts and recommendations that are fair, unbiased and driven solely by professional considerations. The Securities and Exchange Commission (SEC) explicitly requires analysts to be independent, viewing them as “gatekeepers” of the investment community and as having fiduciary responsibilities for investors (Fisch, 2006).1 As evidence of their independence, analysts are required to certify that the opinions expressed in their public reports accurately reflect their own views.

The revolving-door phenomenon is a concern also in other professions on which the public relies for objectivity and independence. For example, serious concerns have been raised about the independence of auditors of public companies who are hired by their client firms. Similarly, whether congressional staff members who gain employment with lobbying firms or credit-rating analysts hired by companies they previously rated are able to maintain their independence has been questioned. In these instances, the possibility of a conflict of interests is mitigated either by requiring a “cooling-off” period or some form of notification. A prime example of this is the cooling-off period specified in the Sarbanes-Oxley Act of 2002 which mandates that publicly-held companies cannot hire their auditor’s former employees in key positions for at least a year.

Despite the possibility of a conflict of interests of revolving-door analysts, a cooling-off period is not required nor is any specific notification mandated. The only regulation pertaining to this situation is Rule 2711 (h)(1)(c) of the National Association of Security Dealers (NASD) which specifies that an analyst must report any “actual, material conflict of interests.” While this rule does not specifically mention the potential conflict of interests arising when an analyst is being considered for employment by a covered firm, clearly this situation would merit such a disclosure. To date, there is only one case where an enforcement action was taken against a revolving-door analyst who failed to disclose in her reports that, at the time these reports were issued, she was being interviewed by the company that was the subject of these reports.4 This failure to disclose is clearly not limited to this single case in which disciplinary action was taken. My examination of the hundreds of relevant research reports issued by revolving-door analysts did not reveal even a single disclosure of a conflict of interests. Further, to the best of my knowledge, the Financial Industry Regulatory Authority (FINRA, formerly NASD) has not taken actions against any of these analysts. This is unexpected rather surprising finding given FINRA’s policy that when “a research analyst is pursuing employment or has accepted a job with a covered company, the NASD rule require that information concerning such a clear conflict of interest must be disclosed in research reports.”


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