Analysts give more favorable ratings to stocks held by their firm’s mutual fund clients, according to a new working paper from Harvard Business School.
The paper’s findings:
An analyst’s recommendation on a stock relative to consensus is significantly higher if the stock is held by the mutual fund clients of the analyst’s brokerage firm.
The optimism in analyst recommendations increases with the weight of the stock in a mutual fund client’s portfolio and the commission revenue generated from the mutual fund client. However, this favorable recommendation bias towards a client’s existing portfolio stocks is mitigated if the stock in question is highly visible to other mutual fund investors.
Abnormal stock returns are significantly greater both for the announcement period and in the long run for favorable stock recommendations from analysts not subject to client pressure than for equally favorable recommendations from business-related analysts.
In addition, subsequent to announcements of bad news from the covered firms, analysts are significantly less likely to downgrade a stock held by client mutual funds.
Mutual funds increase their holdings in a stock that receives a favorable recommendation but this impact is significantly reduced if the recommendation comes from analysts subject to client pressure.