Why Do Analysts Issue Recommendations on Weekends?

Why Do Analysts Issue Recommendations on Weekends?

Yi Dong
University of International Business and Economics

Nan Hu
Stevens Institute of Technology

January 3, 2013


Amendments to NASD Rule 2711 and NYSE Rule 472, enacted in May 2002, mandate sell-side analysts to disclose the distribution of security recommendations in each category of buy, hold, and sell. Such a reform enhances the transparency of analysts’ information, and mitigates the long-recognized optimistic bias in their recommendations. We find, however, that analysts tend to release a disproportionate number of unfavorable recommendations on weekends, when investors are most likely to be inattentive. Market reaction tests suggest an incomplete immediate response to unfavorable recommendations issued on weekends and a prolonged drifting period. Further, analysts engaging in this strategic timing tend to be rewarded by management and to have higher future forecast accuracy. Collectively, our results suggest that, while the new mandate is effective in reducing analysts’ optimistic bias, it leads to a different form of distortion in the capital market.

Why Do Analysts Issue Recommendations on Weekends? 1. INTRODUCTION Serving as information intermediaries, financial analysts gather, process, and generate information that is of significant value to investors’ decision-making. Their vital importance, however, seems to be jeopardized by one distorted incentive – to please management and gain better access to management-provided information. Among various types of information, private managerial information is one of the most important in giving analysts an informational advantage over their peers (Schipper, 1991; Francis and Philbrick, 1993; Chen and Matsumoto, 2006; Ke and Yu, 2006). This underlying incentive can help explain stylized facts such as the optimistic bias in analysts’ forecasts and recommendations. Francis and Phibrick (1993) show that, in an effort to cultivate relationships with management, analysts tend to report optimistic forecasts. Chen and Matsumoto (2006) subsequently demonstrate that analysts who issue favorable recommendations gain better access to management and have higher future forecast accuracy than analysts who issue unfavorable recommendations. Similarly, Ke and Yu (2006) present evidence suggesting that analysts successfully use biased earnings forecasts (initial optimistic earnings forecasts followed by pessimistic earnings forecasts) to please firm management in order to gain better access to their private information. These studies collectively reveal how management rewards (punishes) analysts who issue favorable (unfavorable) forecasts or recommendations by providing them with more (less) information. As a result, to maintain good relationships with managers, analysts exhibit systematic bias in their forecasts and recommendations (Francis and Phibrick, 1993; Lim, 2001; Richardson et al. 2004; Chen and Matsumoto, 2006; Ke and Yu,

This distortion by financial analysts has attracted the attention of regulators. In July 2002, the self-regulatory organizations NASD and NYSE issued amendments to NASD Rule 2711 and NYSE Rule 472 on sell-side research, requiring brokerage firms to disclose, in each research report, the percentage of all securities rated by members to which the member assigns a rating of ‘buy,’ ‘hold/neutral,’ or ‘sell.’ Such regulations aim to enhance the transparency of sell-side research and provide the capital market with more useful and reliable information (SEC Release No. 34-45526). As one might have expected, since the regulations optimistic recommendations have become less frequent, whereas pessimistic recommendations have increased (Kadan et al., 2009). Specifically, during the second half of 2002, the percentage of buy recommendations decreased from 60% to 45%, while that of sell recommendations rose from 5% to 14% (Barber et al., 2006). At first glance, enhanced transparency seems to have reduced analysts’ bias in their recommendations. Utilizing this regulation, we investigate whether analysts strategically time the market when they must release unfavorable recommendations. We argue that analysts may exploit investors’ limited cognitive capacity and strategically issue negative recommendations on weekends, when investors are most likely to be inattentive. Constrained by limited attention, investors neglect some information, particularly when they face more distractions on weekends (Dellavigna and Pollet, 2009). Negative recommendations issued on weekends can therefore spur market response to a lesser extent. Weekend release helps the analyst to avoid reporting too high a percentage of positive recommendations after the enactment of the amended NASD Rule 2711 and NYSE Rule 472, and also reduces the probability of a sharp drop in stock price, thereby pleasing management and maintaining future access to private managerial information.

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