University of Toronto research shows brokers pick stock comparisons to add credibility to recommendations
Analysts who work for brokerages tend to cast the companies they are researching in a positive light by benchmarking them against stocks that are more expensively priced, according to research by the University of Toronto’s Rotman School of Management.
The study, to be published in an upcoming edition of the Review of Accounting Studies, shows brokers who work for the sell side may lend their stock recommendations greater credibility not in the research itself but rather in their choice of peer companies.
The analysts are apparently even more careful to choose peer companies with high valuation when they are researching companies with investment banking affiliations to their own brokerage.
Still, a study researcher says most analysts use reasonable criteria when choosing peer companies. ‘We believe these analysts fulfill an important function in the market,’ says Ole-Kristian Hope, Deloitte professor of accounting at the Rotman School, in a press release announcing the results. ‘That doesn’t mean they’re perfect.’
The study extends beyond previous research that shows brokers tend to be optimistic in their outlook for stock picks by studying how sell-side brokers choose peer companies for comparison. According to the authors, it’s the first large-scale study to do so, though the Rotman School hasn’t yet released the full study data. The researchers conclude, however, that analysts ‘with an established reputation for skilled analyses’ are apparently less susceptible to the temptation to choose peer companies that are over-priced or have high valuations.
Hope co-wrote the study with Gus De Franco, an associate professor of accounting at the Rotman School, and Stephannie Larocque, an assistant professor of accounting at the University of Notre Dame.
