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Hun-Tong Tan*
Nanyang Technological University
Rong-Ruey Duh
National Taiwan University
Shean-Bii Chiu
National Taiwan University
Shu-Hsing Li
National Taiwan University
Corresponding author:
Hun-Tong Tan
Room S3-01C-78, Nanyang Business School
Nanyang Technological University
Tel: 65 67904819
Fax: 65 67937956
Email: ahttan@ntu.edu.sg
We appreciate comments from Wei Chen, Jun Han, Lukas Helikum, Terence Ng, Premila
Shankar, Seet Koh Tan, Elaine Wang, Yao Yu, and Bo Zhou, and research assistance by Lukas
Helikum, Li Xiao, Feng Yeo, and Yao Yu. Hun-Tong Tan acknowledges the generous funding of
the UOB Endowment.
Abstract
In this study, we examine whether buy-side analysts forecasts are biased when they cover stocks
that are held by the mutual fund. Specifically, we conduct an experiment with buy-side analysts
and fund managers where we manipulate whether the forecasts are released to colleagues and
clients or kept private, and whether the mutual fund has made an investment in the stock based
on the recommendation of the analyst. We posit and find evidence that when forecasts are made
available to other colleagues and clients, participants forecasts are more positive when the
mutual fund has a holding (versus no holding) in a stock based on the buy-side analysts
recommendations. These forecasts are also more optimistic than a control group where
participants have an accuracy goal. This effect disappears when the forecasts are kept private.
Our findings indicate that institutional features in the asset management setting create conditions
for buy-side analysts forecasts to be optimistic.
Buy-side analysts are important financial intermediaries who work for asset management
firms and make stock recommendations to fund managers in these firms. Their interpretation of
earnings- and share price-relevant information benefits the segment of investors who place their
funds with the asset management firms that these analysts work for. In this study, we conduct an
experiment to examine two factors that may influence buy-side analysts forecast optimism
whether the mutual fund has made an investment in the stock based on a previous
recommendation of the analyst, and whether the forecasts are released to colleagues and clients
or kept private.
The first factor is an institutional feature present in the buy-side analyst environment.
Buy-side analysts follow up and issue forecasts on stocks already held by the mutual fund, and
they also cover stocks not currently covered by the fund in sourcing for new buy ideas. Further,
in the buy-side analyst environment, a stock held by the mutual fund is also likely one that has
been recommended by the buy-side analyst (Frey and Herbst 2014). Psychology research on
motivated reasoning (e.g., Kunda 1990) and strategic justification (e.g., Caldwell and OReilly
1980; Leary and Kowalski 1990; Schoorman and Holahan 1996) suggests that this can lead to
optimistic forecast bias. Further, although these two aspects (holding, stock recommendation)
naturally co-vary in practice, we attempt to disentangle their separate effects in our study
knowing the cause of the judgment bias (if it exists) allows asset management firms to allocate
The second factor we examine, whether the forecasts are released to colleagues and
clients or kept private, is another institutional feature present in the buy-side analyst
environment, and one that likely magnifies the effect we discussed above. Buy-side analysts
3
forecasts and recommendations are issued with the express purpose of selling stock ideas to the
asset management firm and its clients (Groysberg, Healy, and Chapman 2008). 1 Portfolio
managers we interviewed indicated that, for marketing and client relationship purposes, these
selected clients of the asset management firm.2 These parties are important stakeholders to whom
buy-side analysts are accountable, with a preference for the stocks earnings prospects to be good
should they have a stake in the stock. In particular, if the asset management firm has a stock
holding (e.g., by the fund manager on behalf of a client) based on the buy-side analysts prior
recommendation, the biasing effect of this stock holding discussed earlier is likely heightened if
buy-side analysts are aware that their forecasts will be released to these parties. For instance,
fund managers and clients are likely to be unhappy should they receive pessimistic earnings
forecasts from the buy-side analyst after having acted on the latters previous recommendation to
buy a stock. Psychology research (e.g., Tetlock, Skitka, and Boettger 1989) suggests that under
these circumstances, buy-side analysts are motivated to bias their forecasts upwards to please
these parties.
Investigating these issues is important. The quantum of funds under the charge of asset
management firms is significant, with the value of professionally managed assets rising by 8
percent to US$56 trillion in 2010 (Boston Consulting Group 2010a, 2010b). Buy-side analysts
have significant influence on the asset allocation by asset management firms (Cheng, Liu, and
Qian 2006; Frey and Herbst 2014; Groysberg, Healy, and Serafeim 2013), and judgment biases
1
These recommendations (and the associated earnings forecasts) are likely buy recommendations because asset management
firms generally have restrictions on short-selling (Groysberg et al. 2008). For instance, Frey and Herbst (2014, Table 2) indicate
that only 14 percent of buy-side analysts recommendation revisions involve a downgrade to underperform or sell, and 73
percent of the revisions start from a hold or buy position.
2
The webpage by Graeme Pietersz, former equity analyst, makes a similar point about buy-side analysts reports being made
available to clients (http://moneyterms.co.uk/buy-side-analyst).
4
buy-side analysts is rare, largely because of data availability issues (see Willis 2001 and
Of direct relevance to our study is an archival study by Willis (2001), who analyzes
mutual fund manager forecasts that were publicly released via the media.3 He finds that stock
holdings are positively associated with greater optimism bias. Specifically, he uses a subset of 60
mutual fund managers who issue more than one forecast for a particular day, and finds a positive
correlation (without control variables) between forecast optimism and dollar investment in the
stocks. However, as Willis (2001, p. 721) acknowledges, his study cannot disentangle whether
increased stock holding results in larger forecast optimism, or alternatively, greater forecast
optimism induces greater stock holding. Further, all the forecasts issued by fund managers in
Willis sample relate to stocks that the mutual fund holds, so it is not possible to determine
whether the presence versus absence of a stock holding leads to forecast optimism. The forecasts
in his dataset are publicly available, and it is not possible to disentangle the effect of holding
versus public availability of the forecasts. In short, absence of an appropriate comparison group
to provide direct evidence on the causal relationships among these variables, holding constant the
attributes of the company and the information environment. A constraint in the use of archival
consequence of forecast optimism. Our use of an experimental approach avoids this issue.
Further, an experimental approach allows us to separate out the effects of stock holding from the
3
Willis (2001, p. 708) considers mutual fund managers to be a subset of buy-side analysts. Senior members of asset management
firms tell us that in some asset management firms, buy-side analysts have distinct career paths; in many others, aspiring fund
managers first serve as buy-side analysts before they progress to be fund managers. While fund managers make investment
decisions on behalf of their clients, they also routinely make stock recommendations/forecasts (see also Frey and Herbst 2014).
5
effects of stock recommendation, both of which naturally co-occur in practice and are therefore
manipulate whether the asset management firm has a holding in a stock based on the
recommendation of the buy-side analyst, and whether the participants assume that the forecasts
they make will be kept private, or made publicly available to other fund managers and clients.
Our dependent variable is the earnings forecasts made by the participants. Manipulating the asset
management firms stock holding addresses the difficulty experienced in archival research of
eliminating the alternative explanation that it is forecast optimism that leads to greater stock
holding by the firm, and not the reverse. By also separately manipulating the public/private
nature of the forecast release, we address the issue of whether the findings in Willis (2001) are
We find evidence that forecasts which are made available to other colleagues and clients
are more positive when the mutual fund has a holding (versus no holding) in a stock based on the
buy-side analysts recommendations. This effect disappears when the forecasts are kept private.
The forecasts by a control group where participants are instructed that their goal is to make
accurate forecasts are lower than those made by the holding/public group, and not different from
those in any other condition. This indicates that the holding/public condition leads to an upward
bias in analysts forecasts. In contrast, the fact that there is no apparent bias in the
holding/private condition suggests that the presence of a stock holding does not bias buy-side
As we mentioned earlier, a stock held by the mutual fund is also likely one that has been
recommended by the buy-side analyst (Frey and Herbst 2014). We disentangle the effects of
6
stock holdings per se versus stock holdings based on the buy-side analysts recommendations,
with those from a modified public/holding condition where the participants are not told that the
stock holding is based on the buy-side analysts recommendations. Our results indicate that the
mere holding of a stock by the mutual fund is insufficient to create optimism in the forecasts
issued by buy-side analysts, at least in the public dissemination condition. However, given that it
is somewhat less common to have a fund hold a stock without the current analyst having made
an earlier recommendation, the threat of analyst forecast bias in a public release setting remains.
negative impact of disseminating below-consensus forecasts publicly (versus privately). They are
forecasts when there is a stock holding. We also conducted supplementary experiment using
buy-side analysts/fund managers in which the two dissemination conditions were manipulated
within-subjects in a setting where the mutual fund has a holding in a stock based on the buy-side
analysts recommendations. Results indicate that participants forecasts are higher in the public
condition than in the private condition, suggesting that the effect is conscioushad the effect
been unconscious, it should have disappeared once the public/private difference is made salient
in the within-subjects design. These results, along with our finding that, in the presence of a
stock holding, participants can switch from being objective in a private release setting to being
more biased in a public release setting, suggest that the biasing effect of stock holding in the
Our study contributes to the literature by providing a theoretical account and empirical
evidence on the causal relation between an asset managements holding of a stock through a buy-
7
side analysts previous recommendation and buy-side analysts forecast optimism, and how this
effect is moderated by the dissemination of his/her forecast. Our results extend the archival
finding of a holding effect by Willis (2001) in three aspects. First, that the holding/public
condition (akin to Willis setting) but not the holding/private condition leads to an upward bias in
analysts forecasts suggests that the stock holding effect in Willis (2001) may be attributable to
the public nature of the forecasts in his sample. Second, at least in a public forecast release
setting, it is the stock holding given a prior stock recommendation and not stock holding per se
that is likely driving buy-side analysts forecast optimism. This also has a practical implication
for asset management firms in terms of taking steps to remedy the source of biased forecasts.
Finally, we provide evidence that our findings are the result of a conscious, not sub-conscious
mechanism.
The remainder of this paper is structured as follows. In the next section, we provide
theoretical background and develop our research hypothesis, which is followed by our research
design. The fourth section presents the results. The final section concludes our paper.
While studies involving buy-side analysts have been relatively scarce, there is extensive
research on sell-side analysts behavior. Sell-side analysts work for brokerage firms and issue
stock recommendations for the clientele of the brokerage firms (see Bradshaw 2011 for review).
These studies conclude that sell-side analysts issue optimistic forecasts because of incentives to
attract underwriting business (Lin, McNichols, and OBrien 2005), to generate trading
commission (Cowen, Groysberg, and Healy 2006), or to develop good relationship with
management (Ke and Yu 2006). McNichols and OBrien (1997) offer another explanation,
suggesting that sell-side analysts selectively report their forecasts and stock recommendations by
8
reporting those only when they hold favorable views. Some studies also suggest the possibility of
the institutional settings are different. For instance, unlike sell-side analysts, buy-side analysts do
not have incentives to please management of the firm they are analyzing. Further, the asset
Little is known about the institutional setting within which buy-side analysts operate, and
how these institutional features influence the forecasts they issue. Archival data on buy-side
analysts forecasts are generally unobservable as they are proprietary in nature. Hence, there
have been few studies on this issue, with two notable exceptions: Willis (2001) and Groysberg et
al. (2008) analyzed proprietary data of buy-side analysts from a mutual fund.4 Both conclude that
buy-side analysts forecasts are optimistically biased. However, neither examines specific
institutional features in the buy-side analyst environment that influence this forecast optimism.
Studies involving buy-side analysts as participants in experimental settings have also been
relatively scarce, and those that do so predominantly use them as proxies for sophisticated
investors (e.g., Hopkins, Houston, and Peters 2000; Miller and Sedor 2014), but not as direct
subjects of interest (one exception is a study by Ashton and Cianci 2007, which compares the
4
Groysberg et al.s (2008) dataset partially addresses a concern in Willis (2001) dataset that forecasts which are publicly
available tend to be optimistic to manage public expectations. Note that fully private forecasts do not exist in Groysberg et al.s
(2008) sample, just like those in Willis (2001) sample. Some of these forecasts are open to the firms fund managers and
potentially clients as well, who likely have taken positions based on these buy-side analysts recommendations (see Frey and
Herbst 2014). In addition, because the mutual fund analyzed in Groysberg et al. (2008) is one that prohibits short selling, it is
likely that the forecasts made, including those for newly covered firms, are those that the analysts recommend holding (or had, at
some point in the past, recommended holding).
9
Effect of Stock Holdings Based on Buy-Side Analysts Recommendations5
Prior research documents what we term a stock holding effect in that investors with a
long position (i.e., a holding) in a stock tend to assign higher earnings estimates than those with a
short position in an identical firm (Hales 2007). Han and Tan (2010) show that investors with a
stock holding (long position) tend to make higher earnings estimates compared to those with no
stock holding (a neutral position) when given positive management guidance provided in the
form of range guidance. This stock holding effect has also been documented among sell-side
analystsstock recommendations originating from sell-side analysts are more optimistic if the
stock is held by the brokerage firms mutual fund clients and particularly so when trading
commissions paid by the clients increase (Firth, Lin, Liu, and Xuan 2013).
Prior research (e.g. Hales 2007; Han and Tan 2010) maintains that the psychological
mechanism responsible for this stock holding phenomenon is related to a directional preference
effect, where the desire for a preferred outcome influences ones assessment of the likelihood of
that event occurring (Krizan and Windschitl 2007). This effect is also broadly related to the
and process information in a manner that fits in with their directional goals, subject to
reasonableness constraints (for examples of accounting studies, see Eames, Glover, and Kenney
2002; Kadous, Kennedy, and Peecher 2003; Wilks 2002). In the context of our study, buy-side
analysts are employees of the asset management firm and it is conceivable that the firms stock
holding in itself is sufficient to induce unconscious motivated reasoning among these analysts
5
We develop our theory below with reference to buy-side analysts. Similar arguments apply for fund managers. For instance, the
fact that an asset management firm has a holding in a stock per se does not lead fund managers to have directional preferences for
the stocks earnings and price performance to improve. The fund manager has to be the one who made that recommendation.
Similarly, fund managers (particularly small cap fund managers; see Frey and Herbst 2014) do periodically make stock
recommendations and earnings forecasts that are accessible to other fund managers and selected clients.
10
A counter-point is that the buy-side analyst setting is distinct from an investor or sell-side
analyst setting in that the buy-side analyst does not have a direct holding in a stock (as with
investors) or benefit from increased commissions when clients with larger stock holdings trade
more (as with sell-side analysts). 6 Hence, the funds holding of a stock may not, by itself, evoke
motivated reasoning by buy-side analysts. On the other hand, a distinctive institutional feature in
the buy-side analyst environment is that an asset management firms asset and fund allocation
(and, therefore, stock holdings) are significantly influenced by in-house buy-side analysts
recommendations (Cheng et al. 2006; Frey and Herbst 2014), which means that if the asset
management firm has a stock holding, it likely originated from a recommendation by the in-
Fund managers we spoke to mentioned that within an asset management firm, there is
stiff internal competition among buy-side analysts for stock ideas to be adopted by fund
managers, 8 and therefore, pressure for the adopted stock to perform well. This competition for
fund managers attention and asset allocation implies that a buy-side analysts recommendation
may not translate into a position by an asset management firm. It also suggests that once a stock
recommendation is adopted by the asset management firm and translated into a stock holding,
6
In the case of sell-side analysts, their brokerage firms earn commissions from their clients and sell-side analysts rewards are
tied to this commission income. Hence, they have direct financial incentives to optimistically bias their reports to please their
clients who already hold the stock. Optimistic reports sustained over time also encourage more trading by the clients, and clients
with large stock holdings who trade more directly increase the analysts commission income. Unlike sell-side analysts, buy-side
analysts do not directly benefit from trading by the fund managers (Cheng et al. 2006).
7
Our fund manager contacts also confirmed this, and further indicated that within an asset management firm, a single buy-side
analyst generally covers a particular stock (see also Groysberg et al. 2008). We surveyed 49 fund managers and asked whether, in
their asset management firms, fund managers stock holdings result from stock recommendations by internal buy-side analysts.
About 86 percent of them indicate that this is the case.
8
This competition likely explains why a majority of buy-side analysts forecasts involve buy/hold recommendations. Frey and
Herbst (2014) find that for the dataset of forecasts issued by buy-side analysts from a global asset management firm, a majority of
recommendation revisions involve an upgrade to hold or buy recommendations. Frey and Herbst (2014) document that over 73
percent of all recommendation revisions start from at least a hold recommendation, and their Table 2 indicates that approximately
83 percent of all recommendation revisions involve an upgrade.
11
Thus, buy-side analysts can have a vested interest in the earnings and performance of the
company under coverage if the asset management firm has made an investment in the stock
through their recommendations. Specifically, two conditions are necessary: (a) the asset
management firm has made an investment in the stock, and (b) the investment is based on the
buy-side analysts recommendation. Both conditions are inter-related in the asset management
environment, and these features imply that two competing mechanisms may be at play here.
The first mechanism is motivated reasoning (Kunda 1990). Given the link between the
asset management firms stock holding and the buy-side analysts recommendation, the career
consequences of bad recommendations strengthen the personal stakes for the buy-side analysts
and therefore their preferences for the stock to do well. Motivated reasoning predicts that this
important aspect of this motivated reasoning mechanism is that it is unconscious (Kunda 1990).
management tactic aimed at altering the recipients impression of the event (Schlenker and
Weigold 1992). Research on impression management indicates that decision makers actively use
different means to seek to influence significant others impression of themselves (see Leary and
Kowalski 1990 for a review), and this results in strategic endorsement or justification of specific
attitudes (Gaes, Kalle, and Tedeschi 1978) and escalating commitment to a failing course of
action (Brockner, Rubin, and Lang 1981; Staw 1981; Schoorman and Holahan 1996). The
motivation to manage the impressions of others is strong when the decision maker is personally
identified with and held responsible for the decision and has his/her reputation staked on its
success. For instance, Caldwell and OReilly (1980) documented how responsibility for a failed
outcome led to greater impression managementin their study, decision makers held responsible
12
for a failed outcome engaged in impression management by strategically presenting more
favorable information to their superiors. In our current setting, the buy-side analyst is responsible
for the firms stock holding (having made the stock recommendation), and his/her reputation is
staked on the stock performing well. Issuing more optimistic earnings forecasts signals to
important stakeholders that the buy-side analyst is confident about the stocks prospects. It is
also a way to justify his/her buy recommendation.9 Consistent with this argument, an archival
study by Eames et al. (2002) finds evidence that analysts bias their forecasts upwards/downwards
in a direction that supports their buy/sell recommendations. 10 Bradshaw (2002) also finds
evidence consistent with the argument that sell-side analysts use target prices to justify their
stock recommendations. There are two important aspects and assumptions in the strategic
justification mechanism: (a) the justifications (whether in the form of earnings forecasts,
recommendations or target prices) have to be publicly seen by the target audience whose
impressions the analysts desire to manage, and (b) the resulting bias is conscious.
Effect of Stock Holding via Analysts Recommendation: Public versus Private Disclosure
The different assumptions made by the two competing mechanisms permit us to make
predictions and test which mechanism holds in the buy-side analyst institutional setting. The
strategic justification mechanism involves the need to impression manage, and requires that the
for the stock to do well (for instance, earnings to be higher than consensus). Since the
9
This strategic justification effect does not apply to the earlier setting when we consider the mere effect of the asset management
firm having a stock holdingin that setting, we do not consider the case where the holding is based on the analysts
recommendation, and so, the issue of the analyst having a reputational stake in the successful outcome of the recommendation
does not arise.
10
Eames et al. (2002) argue that their results are consistent with an unconscious motivated reasoning rather than an intentional
trade boosting argument. However, their results are also consistent with an intentional strategic justification effect that we discuss
here.
13
unfavorable consequences result whether the forecasts are publicly disseminated or not,
motivated reasoning should occur in both public and private dissemination settings. We
elaborate on this below and discuss our predictions in the public setting followed by the private
dissemination setting.
The public dissemination setting is a naturally occurring feature in the buy-side analyst
environment in that the analysts forecasts are made public to other analysts and fund managers
in the firm, along with clients. Buy-side analysts forecasts and recommendations are issued with
the express purpose of selling stock ideas to the asset management firm and its clients
(Groysberg et al. 2008).11 Portfolio managers we interviewed indicated that, for marketing and
disseminated to fund managers and selected clients of the asset management firm.12
In this public dissemination setting, suppose that, after the asset management firm had
management issues guidance that is lower than consensus forecasts. The motivated reasoning
mechanism maintains that because buy-side analysts prefer that their recommended stock to have
good future prospects (as this has career consequences for them), they will issue more optimistic
forecasts, albeit unconsciously. The strategic justification mechanism makes a different argument
but predicts the same effect. Given the public dissemination, fund managers and clients of the
asset management firm, who are important stakeholders to the buy-side analyst, are likely to be
unhappy about the professional advice they received from the buy-side analyst should they
subsequently receive pessimistic earnings forecasts about the stock. The strategic justification
11
These recommendations (and the associated earnings forecasts) are likely buy recommendations because asset management
firms generally have restrictions on short-selling (Groysberg et al. 2008). For instance, Frey and Herbst (2014, Table 2) indicate
that only 14 percent of buy-side analysts recommendation revisions involve a downgrade to underperform or sell, and 73
percent of the revisions start from a hold or buy position.
12
The webpage by Graeme Pietersz, former equity analyst, makes a similar point about buy-side analysts reports being made
available to clients (http://moneyterms.co.uk/buy-side-analyst).
14
mechanism maintains that in this public dissemination setting, the buy-side analyst has a high
need to impression manage and justify the appropriateness of his/her prior recommendation,
which intensifies his/her defensive bolstering as to why the recommendation is correct (Lerner
and Tetlock 1999). Consciously issuing more optimistic forecasts is a way to achieve this.
dissemination setting, which makes it impossible to distinguish the two mechanisms. However,
setting that we can create in an experimental setting, where the buy-side analysts make private
Motivated reasoning is unconscious (Kunda 1990), so one would expect an effect of the
asset management firm holding the stock based on the buy-side analysts recommendation even
in a private forecast setting. The reputational and career consequences of a bad recommendation
equally apply, whether the forecasts are made publicly or privately. If this concern about the dire
reputational and career consequences looms large such that it has unconscious effects on the buy-
private and public forecast dissemination settings. 13 In contrast, the strategic justification effect
is a conscious effect arising from the need to justify ones prior actions to others, and in our
setting, issuing more optimistic forecasts for the consumption of stakeholders is one way to do so.
In contrast, when a forecast is kept private, there is no need to upwardly-bias earnings forecasts
13
It is conceivable that holding effects are stronger in a public (versus private) dissemination setting because of
stronger directional preferences, or remain equally strong across public and private settings because the directional
preferences are already present in a private dissemination setting. All the studies on motivated reasoning that we
are aware of use settings where there is no public dissemination of the participants judgments, akin to a private
dissemination setting we use here (see Hales 2007, Han and Tan 2010 for accounting examples). The
theoretical mechanism argues that this is an unconscious process that should apply even when there is no
concern that the forecast provided will be seen and evaluated by a significant other.
15
when there is a stock holdingthese forecasts will not be seen by others to begin with; in other
words, there is no stock holding effect. In essence, these private forecasts are the buy-side
Predicting a stock holding effect in a setting where the analyst privately expresses his/her
true beliefs does require a relatively strong assumption about the pervasiveness of this stock
holding bias. Survival in the highly-competitive buy-side analyst labor market requires these
analysts to be able to separately generate private beliefs about a stocks prospects that are
stripped of incentive-driven bias, so it is possible that buy-side analysts are able to purge
reasoning, such that we do not predict this effect in a private forecast disclosure setting. Further,
while prior demonstrations of directional preferences effects involve personal holdings of a stock
(e.g., Hales 2007; Han and Tan 2010), the buy-side analyst setting involves one where the stock
holding is indirect (via the company the analyst is working for), notwithstanding an involvement
by the analyst in that the firms holding arises from the analysts stock recommendation. Thus,
the motivated reasoning effect may be weaker in this setting. Overall, we anticipate that this
weaker form of the stock holding bias will be more likely, consistent with the strategic
justification mechanism. Referring to the graphical depiction (Figure 1) of our ordinal interaction
prediction, this suggests a positive stock-holding-effect slope in the public forecast condition,
and a flat line (no stock holding effect) in the private forecast condition. There is no incentive or
preference by buy-side analysts for the stock to perform in the no-holding condition, so we do
not anticipate any effect of public versus private forecasts here. This also suggests that the
combination of public dissemination and stock holding induces the most optimistic forecasts
16
among buy-side analysts, and no difference across the other conditions. Our hypothesis is stated
below:
Hypothesis 1. When buy-side analysts earnings forecasts are made public, their forecasts will
be higher when the asset management firm holds a stock made through their recommendation
than when it does not do so, but their forecasts will not be induced higher by the firms stock
holding when their forecasts are kept private.
We note that our theory and design allow us to determine which mechanism is in place.
In a public forecast dissemination setting, we expect a positive slope in Figure 1, based on both
setting, a positive but less steep slope is consistent with the motivated reasoning mechanism,
RESEARCH METHOD
Participants
Our participants were fund managers and buy-side analysts from 13 international firms
and 14 major Taiwanese firms.14 We include both fund managers and buy-side analysts in our
sample because fund managers are a subset of buy-side analysts (see footnote 5), and most of the
fund managers in our sample have prior experience as buy-side analysts. For brevity, we
collectively term our participants buy-side analysts. One of the authors contacted these firms
senior executives and obtained their agreement to provide participants. We then sent the research
instruments to these executives, and asked them to distribute the instruments to their staff for
completion. In total, we distributed 440 copies of the instruments and received 250 usable
14
International firms are branches or subsidiaries of asset management firms whose major shareholders are not Taiwanese firms
or individuals; local firms are those whose major shareholders are Taiwanese firms or individuals. Both types of firms follow
similar practices.
17
responses (response rate of about 57 percent). We omitted 19 respondents as their earnings
estimates were outliers, being more than three standard deviations apart from the other responses
and/or erroneous (annual EPS less than sum of quarterly EPS). Among the final sample of 231
usable responses from participants, 154 were fund managers (average of 5.6 years as fund
manager, 5.9 years previously as buy-side analyst, 10.4 years in finance), 63 were buy-side
analysts (average 3.5 years as buy-side analyst), 5 indicated others, and 9 did not include their
designations.15,16 On average, the scale of funds managed by these firms and participants added
to US$38 billion and US$179 million, respectively. The average number of employees in the
firms was 108 and the participants average length of experience in finance was 8.6 years.
Design
Our design was a 2 x 2 + 2 between-subjects design. The first factor we manipulated was
Holdingin the Holding condition, consistent with the institutional features discussed earlier,
participants were told that the asset management firm had invested a significant portion of its
funds in a target stock based on the participants prior recommendation. In the No Holding
condition, they were told that the firm had not made any fund allocation to the stock.17 The
second factor we manipulated was Dissemination (private, public), which varied whether the
buy-side analysts forecasts would be kept private for their own use or released to others
15
Our results are very similar and tests of the holding-plus-recommendation effect remain significant when we separately analyze
the data using only the fund manager sample. Our results are directionally similar but become insignificant if we only use the
buy-side analyst sample as this is a much smaller sample (with n = 6 in some conditions).
16
Among these participants, 59% are from Taiwanese firms and 41% from international firms. We also included firm type (local,
international) as a third independent variable. Our results for our hypothesis tests are very similar, and firm type does not
moderate our results (F(1, 128)=0.023, p = 0.880). Our results are also not influenced by other demographic background such as
experience or firm size.
17
In the No Holding condition, we do not indicate that the asset management firm has no stock holding based on the buy-side
analysts recommendation to sell (or not to hold) the stock. Once the firm has no holding in a stock (and there is subsequently bad
news related to this stock), the analysts directional preferences for the stock to perform well or strategic justification effects will
be lower whether the analyst had made a prior recommendation not to hold the stock. Importantly, when an asset management
firm does not currently have a stock holding, it is less likely that this is because the buy-side analyst has made a sell
recommendation. For instance, Frey and Herbsts (2014) find that the majority of all recommendation revisions involve upgrades
(see footnote 11).
18
(including colleagues and clients). The Private Dissemination condition, where the buy-side
analysts forecasts are known only to themselves, is one that does not exist in the institutional
setting of asset management firms (although it is plausible that buy-side analysts form private
forecasts that they then adjust before making these forecasts public). We capitalize on the
comparative advantage of the experimental method to include this condition which serves as a
clean baseline to assess the effect of public dissemination of the analysts forecasts, one that is
not possible using archival data. We also included an Accuracy Goal condition where
participants were instructed that their goal was to be as accurate as possible in their earnings
Finally, to disentangle the incremental effect of having made a personal recommendation to hold
the stock from the firm having a stock holding, we also incorporated a modified Holding/Public
condition which was identical to the Holding/Public condition except that participants were not
told that the stock holding arose out of their stock recommendation.
Procedure
Our instrument was adapted from Han and Tan (2010), and modified based on a pilot test
and interviews with senior fund managers. In the experimental materials, we provided all
participants with identical background information about the industry, products, markets and
competition of the target company (Kappa, Inc.). We also gave all participants the companys
history of earnings in the past three years, including quarterly and annual earnings in year X1
and year X2, and quarterly earnings for the first and second quarters of year X3. They were also
provided with the consensus forecasts for the third quarter ($0.25) and the whole ($0.80) of year
X3 that were announced after the second quarter of year X3. In addition, participants received
managements earnings guidance for the third quarter of year X3 ($0.16 to $0.20), which was
19
below consensus forecast. We use this bad news setting so that effects of directional
preferences or strategic justification would be apparent in that these mechanisms would result in
more optimistic forecasts, whereas the news would suggest otherwise. The effects of these
mechanisms would be directionally similar in a good news setting where guidance is above
consensus forecast.
Participants in the experiment were asked to make a forecast of the target companys
earnings. Our instructions to participants after the provision of managements guidance for X3
quarter 3 varied depending on the experimental condition they were assigned to.18 In the Holding
condition, participants were told to assume that just before Kappas announcement, your firm
has allocated a fairly significant portion of its funds in Kappa based on your recommendation.
In the No Holding condition, they were told to assume that their firm has not made any fund
allocation to Kappa. In the Private condition, they were asked to assume that the forecasts that
they made will be kept private for their own use only, and not released to others, including
colleagues and clients. In the Public condition, they were asked to assume that the forecast that
they made will be released to others, including colleagues and clients. After reading these
instructions, all participants were asked to provide Kappas EPS forecasts for the third quarter of
year X3, full-year X3, and full-year X4. After they had made the forecasts, all participants
RESULTS
18
The guidance and manipulation instructions appear on the same page, with the guidance appearing before the manipulations
instructions. This mimics a real-world situation where buy-side analysts read/hear about management guidance in the
press/conference calls, and are immediately reminded of their prior stock recommendations.
20
As a check on our Holding manipulation, we asked participants to indicate the amount of
funds their firm had allocated to Kappas stock, with the options being either no earlier fund
allocation or a significant fund allocation to Kappa based on their previous recommendation. The
modified Holding condition contained the same manipulation check but without the words
based on your previous recommendation. About 78 percent of the respondents answered this
indicate whether they assumed their earnings forecasts would be released to others (including
colleagues and clients) or kept for their own use. About 68 percent of the participants correctly
answered this question. Subsequent debriefing with some of the participants indicated that they
understood the manipulations, but misinterpreted the debriefing questions. We also engaged in
an extensive debriefing exercise with a sample of 30 participants at the end of our session, after
verify that they understood and correctly interpreted the manipulations. All of them did. As such,
In our experimental materials, the most recent update on future earnings came from the
third quarter earnings guidance from management, who provided below-consensus guidance for
that quarter. Our primary dependent measure is, therefore, participants third quarter earnings
estimates.20 Given our ordinal interaction prediction associated with our hypothesis, we test this
19
Our results become either marginally significant or insignificant when we drop participants with manipulation check failures.
20
As with the Q3 forecasts, for the full-year X3 forecasts, we also find no significant effects of holding (versus no holding),
given private dissemination (means=80.5 and 83.3, respectively; t132=0.855, p=0.394), and a significant effect of holding (versus
no holding), given public dissemination (means=82.6 and 76.6, respectively, t132 = 2.030, p = 0.022, one-tailed). The two-way
interaction using the conventional ANOVA test is significant (F(1,132) = 3.984, p = 0.048), but not the overall contrast test
(F(1,132) = 1.051, p = 0.307), suggesting that the full predicted pattern is not supported. For full-year x4 forecasts, none of these
comparisons or tests is significant (smallest p = 0.329). The stronger results for the quarter 3 forecasts compared to annual
forecasts likely occurred because in our experiment, management provided guidance (in the form of a range) only for quarter 3
but not full-year earnings, and thus, the quarter 3 guidance served as the strongest basis for the analysts to make their forecasts.
The study by Han and Tan (2010), which uses a similar setting, also finds significant results with quarter 3 forecasts but not full-
year forecasts. An alternative explanation may be that the buy-side analysts deliberately attempted to bias only short-term but not
long-term earnings.
21
hypothesis using contrast-coded ANOVA to maximize the power of our tests (Buckless and
Ravenscroft 1990; Rosnow and Rosenthal 1995; see also Sedor 2002 and Seybert 2010 for
applications in accounting settings). Table 1, panel A shows the descriptive statistics. Table 1,
panel B reports the ANOVA results, which shows a marginally significant Holding x
ANOVA results, while Table 1, panel C reports tests of simple main effects. Figure 2 illustrates
Hypothesis 1 predicts that when buy-side analysts earnings forecasts are made public,
their forecasts will be higher when the asset management firm holds a stock made through their
recommendation than when it does not do so, but their forecasts will not be induced higher by
the firms stock holding when their forecasts are kept private. We perform an overall test for this
ordinal interaction using contrast weights of 3 for the Public/Holding condition, and -1 for the
remaining conditions. The contrast-coded ANOVA results show that the contrast is statistically
significant (F(1, 132) = 3.476, p = 0.032, one-tailed; Panel B of Table 1). The residual mean
insignificant (F(2, 132) = 0.043, p = 0.957), which implies that there is no significant between-
As further analyses, we conduct tests of simple main effects (see Panel C of Table 1).
Results show that when the forecasts are made public, participants quarter three forecasts are
significantly higher when their firm holds the stock (mean = 20.38 cents) than when it does not
(mean = 19.17 cents; t132 = 1.699, p = 0.046, one-tailed). Participants forecasts are not
significantly different whether the fund holds the stock (mean = 19.08 cents) or not (mean =
19.56 cents; t132 = 0.606, p = 0.545) when the forecasts are kept private. This result is consistent
22
with the strategic justification effect, which predicts no effect when forecasts are kept private, 21
and inconsistent with the motivated reasoning effect, which predicts an effect here.
We also analyze the simple main effects of public versus private dissemination. Table 1,
panel C shows that consistent with our theory, in the Holding condition, participants forecasts
are higher when the forecasts are made public (mean = 20.38 cents) than when they are kept
private (mean = 19.08 cents; t132 = 1.684, p = 0.047, one-tailed). However, when the asset
management firm does not hold the stock, forecasts that are made public or kept private are not
significantly different (means = 19.17 cents and 19.56 cents; t132 = 0.528, p = 0.599). This latter
result is broadly consistent with the idea that the positive effect on forecasts associated with
A premise we make is that the Public/Holding condition is biased, or at least, more biased
than the other conditions. To verify that a bias exists, we create an Accuracy Goal condition
where participants were told that their goal was to be as accurate as possible in their earnings
forecasts. They were not informed of any stock holding position by their firm, or whether their
forecasts would be communicated to others (or kept private). The mean Q3 earnings forecasts of
21
We coded participants rationale for their earnings forecasts, and computed a Netpositive measure by taking the number of
positive issues minus the number of negative issues mentioned. We find no significant main or interaction effect (p > 0.175).
However, an a priori contrast test indicates that Netpositive is higher in the Public/Holding condition than the average of the
other three conditions (p = 0.038, one-tailed). Netpositive is also higher in that condition than each of the other conditions (p <
0.100, one-tailed) except for the Public/No Holding condition (p = 0.108, one-tailed).
22
We also measured the extent to which participants recommend the stock and the extent to which they believe the stock price
will appreciate in the future. Our manipulated variables do not interactively influence these measures. However, we find evidence
that their quarter three earnings estimates influenced their stock recommendation and stock price appreciation potential
judgments. Both these measures are correlated with their quarter three earnings estimates (r > 0.31, p = 0.000). Furthermore, with
either of these measures as the dependent variable, ANCOVA with our manipulated variables as independent variables and
quarter three earnings estimates as covariate indicates that the coefficient on quarter three earnings is statistically significant (p =
0.000). The interaction term involving our manipulated variables becomes statistically insignificant (p > 0.426).
23
the 25 participants is 18.72 cents, which is lower than that in the Public/Holding condition (t156 =
2.118, p = 0.018, one-tailed), but not significantly different from any of the other conditions (p >
0.297).23 This analysis provides evidence that the Public/Holding condition leads to upwardly-
In this section, we investigate whether stock holding per se induces forecast optimism.
Because of data constraints, we restrict this investigation to the Holding/Public condition, one
where we expect the largest forecast optimism. We do not examine the incremental effect of
holding per se in a Private setting because we expect the effect of holding (in the presence of a
In the Holding condition, we instructed participants to assume that the firm had invested
whether informing participants that the firm has a holding in a stock (without specifying that this
their forecasts will be released to others (including colleagues and clients), participants in this
condition are also informed about the following: Assume that just before Kappas
announcement, your firm has allocated a fairly significant portion of its funds in Kappa. We
restricted this modified Holding condition to the Public condition because the Public (relative to
the Private) condition is the one where we expect the larger effect of stock holding.
23
Specifically, the mean Q3 earnings forecast in the Accuracy Goal condition is not significantly different from that in the
Private/No Hold condition (t156 = 1.046, p = 0.297), the Private/Hold condition (t156 = 0.415, p = 0.678), or the Public/No Hold
condition (t156 = 0.562, p = 0.575).
24
Participants (n = 70) 24 mean Q3 forecast in the modified Holding/Public condition is
18.73 cents, significantly lower than the 20.38 cents forecast in the Holding/Public condition (t225
= 2.246, p = 0.026). This forecast in the modified Holding/Public condition is not different from
the 19.17 cents forecast in the No Holding/Public condition (t225 = 0.580, p = 0.563) or the
Accuracy Goal condition (t225 = 0.010, p = 0.992). Thus, in the absence of information about a
direct involvement in making the stock recommendation, stock holding per se, even with public
These results are informative from a theoretical perspective in that it shows that it is not
the firms stock holding per se that creates the directional preferences for the buy-side analyst,
but the incremental effect of personal recommendation leading to the firms stock holding that
does so. 26
Supplementary Experiment
To provide more direct evidence that participants consciously provide different forecasts
under the two dissemination conditions, we conducted another experiment with twenty-one fund
managers and 4 buy-side analysts. Their average experience in finance is 9.68 years. The average
experience as fund managers and buy-side analysts is 5.09 years and 5.98 years, respectively.
The fund size managed by their firms and by the participants is US$26 billion and US$82
24
During the administration of the experiment, we inadvertently distributed more copies of this instrument than the others, and
correspondingly received more responses back.
25
The fact that we find no effect of stock holding alone in the Public condition (one where we expect stronger effects compared
to the Private condition) also suggests that stock holding alone is unlikely to have an effect in the Private condition.
26
In the post-experiment section, we assessed participants general preferences for private versus public release of their forecasts,
and asked them to respond to questions about another hypothetical company based on their general experiences. Specifically, for
one question, we asked participants to assume that they had estimated Company As earnings per share to be above consensus
forecast based on managements guidance, and to indicate whether they preferred that their earnings estimates for Company A
were kept private or released to others (including colleagues and clients). They answered the question on a 15-point scale (-7:
definitely prefer my estimates to be kept private, +7: definitely prefer my estimates to be released to others). We then asked them
a second question which was identical to the first question except that they were to assume that they had estimated Company As
earnings to be below consensus. The mean responses to the two questions are 0.196 and -0.226, respectively, with the difference
being statistically significant (pairwise difference t132 = 2.509, p = 0.013). Thus, participants have a preference for their forecasts
to be kept private if they issued below-consensus earnings rather than above-consensus forecasts. This result is consistent with
participants being aware of the self-presentation effects of public versus private dissemination of their forecasts.
25
million, respectively. While the size of funds managed by the participants and their firms is
smaller than that in the main experiment, the experiences of the participants are about the same
forecasts for the Private condition followed by the Public condition (n=12), or vice versa (n=13).
We provided the participants with the same background information about Kappa Inc. as in the
main experiment. We only asked them to provide the earnings forecast for Kappa, Inc. for the
third quarter of Year X3, unlike the main experiment where we also asked them to provide full
Both within-subjects conditions involve the firm having a stock holding based on the
prior recommendation of the analyst, the setting where both motivated reasoning and strategic
setting, however, the motivated reasoning mechanism predicts no difference in this within-
subjects settingsince the effect is unconscious, it should disappear once the public/private
difference is made obvious in the within-subjects design. In contrast, the strategic justification
mechanism is a conscious process, and predicts higher forecasts in the Public condition than in
The results indicate a significant main effect of Dissemination, with the mean forecast
under in the Public condition higher than that in the Private condition (means = 0.1932 and
0.1904, respectively; F (1, 23) = 3.520; p = 0.0365, one-tailed). The interaction with order is not
significant (F (1, 23) = 0.116; p = 0.368, one-tailed). This result is consistent with participants
intentionally and strategically offering higher forecasts in the Public (versus Private) setting,
consistent with the strategic justification mechanism. The motivated reasoning mechanism would
26
have predicted no difference in this within-subjects setting (since the effect is unconscious, and
the within-subjects design make the public/private difference obvious to the participants).
CONCLUSION
In this study, we conduct an experiment with buy-side analysts and fund managers where
we manipulate whether the mutual fund has made an investment in the stock based on the
recommendation of the analyst, and whether the forecasts are released to colleagues and clients
or kept private for their own use. While an asset management firms stock holdings are
results suggest that the reverse is, paradoxically, also truebuy-side analysts forecasts can be
influenced by the very stock holdings that the firm holds, particularly when these forecasts are
disseminated to other fund managers and external clients. We also note that while buy-side
analysts forecasts are not publicly disseminated to the market like those made by sell-side
analysts, the parties receiving buy-side analysts forecasts are targeted and important
stakeholders (e.g., fund managers who evaluate them). Further, while not all clients receive the
asset management firms forecasts for various stocks, selected clients do and they are generally
Our study provides the first demonstration of a causal link between stock holdings based
understanding of how two institutional features within an asset management firm context lead to
optimism in buy-side analysts forecasts. Our finding that it is the Holding/Public dissemination
condition that leads to optimistic forecasts has implications for asset management firms in terms
of measures they can adopt to reduce forecast optimism among their analysts. There is probably
27
little that asset management firms can do to prevent dissemination of buy-side analysts forecasts
within the firm, given that these forecasts are intended for use within the firm. There is also
probably little the firm can do to avoid the effect of stock holding because buy-side analysts
necessarily cover the stocks that the firm holds. Further, our interviews with senior fund
managers and the results in Frey and Herbst (2014) indicate that asset management firms stock
holdings generally result from stock recommendations from buy-side analysts, which imply that
in practice, these stock holdings will induce forecast optimism among buy-side analysts (because
they are generally involved in the firm taking a holding in the stock). However, our results on the
modified public dissemination/holding condition, where participants are merely told of a stock
holding but not an involvement through having made a stock recommendation, is instructive.
The results indicate that it is this involvement in having made a recommendation that is an
important factor in inducing optimism in their forecasts. Further, our results showing that it is an
intentional bias suggest that removing the incentives to be biased will be beneficial. An
implication, therefore, is that asset management firms may benefit from having more than one
buy-side analyst cover the same stock. Our understanding from fund managers is that a common
industry practice is for a single buy-side analyst to cover a single stock, which likely exacerbates
the bias we document in this paper. One possibility then is for the asset management firm to
engage another analyst to cover the stock (in addition to the one who had made the
recommendation) once a stock holding has been made. The second analyst, not having made the
rotation of analysts covering a particular stock. These measures do entail costs to the firm and/or
analyst.
28
Our study is subject to some limitations. One limitation is that because of participant
constraints, we do not have a full factorial design where we systematically cross whether the
analyst has made a stock recommendation with the firms stock holding across the forecast
dissemination conditions. Thus, while we know the incremental effect of having made a stock
recommendation that leads to a stock holding when there is public dissemination of the forecasts,
we do not know its effect with private dissemination. Our expectation though is that given the
absence of an effect of stock holding with recommendation when there is private dissemination,
the sole effect of recommendation itself is unlikely to be significant. In addition, we do not know
whether the act of having made a recommendation (absent holding) is sufficient to induce
optimistic forecasts with public dissemination. While this issue is of theoretical interest, our
discussion with fund managers indicate that it is relatively rare for asset management firms to
publicly release forecasts of stocks that they do not already hold. Also, we examine a context
involving a single stock. In practice, buy-side analysts cover several stocks and it is possible that
an ill-timed recommendation for a single stock does not matter if the other stocks recommended
in their portfolio are doing well. Suffice to say, buy-side analysts work in an institutionally rich
environment. Our study identifies two integral institutional aspects of asset management firms
that influence buy-side analysts forecasts, and it is fruitful for future research to examine the
29
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32
FIGURE 1
Ordinal Interaction between Holding and Dissemination Predicted by Hypothesis 1
Earnings
Forecast
interact
Public
dissemination
Private dissemination
No Holding Holding
33
FIGURE 2
Results for Hypothesis 1
Earnings
Forecast
20.5
20 Public
dissemination
Private
19.5 dissemination
19
18.5
No Holding Holding
34
TABLE 1
Overall Descriptive Statistics and ANOVA Results
35
a
Panel A reports mean earnings forecast and standard deviation of participants in each of the four
conditions. In the Holding condition, participants were told that the asset management firm had invested a
significant portion of its funds in a target stock based on the participants recommendation. In the No
Holding condition, they were told that the firm had not made any fund allocation to the stock. In the
Public condition, they were told that their forecast would be released to others, including colleagues and
clients. In the Private condition, they were told that their forecast would be kept private for their own use.
b
Panel C reports the results of a contrast-coded ANOVA with contrast weights of 3 for the
Public/Holding condition and -1 for the other conditions.
*one-tailed
36