Conflict-of-Interest Reforms and Investment Bank Analysts’ Research Biases

This study examines the consequences of the series of reforms targeting investment banking–related conflicts of interest. The authors compare and contrast optimism biases in analysts’ stock recommendations and earnings forecasts across different types of analyst firms in the postreform period of 2004 to 2007 versus the prereform period of 1998 to 2001. The authors document a significant reduction in the relative optimism of sanctioned investment bank analysts’ stock recommendations but not in their earnings forecasts. Moreover, the authors find little change in the profitability of their stock recommendations but detect a drop in the accuracy of earnings forecasts made by investment bank analysts. In sum, the reforms achieve the objective of mitigating the apparent optimism in investment bank stock recommendations, but they do not provide benefit to investors in terms of more profitable recommendations or more accurate earnings forecasts.