Hedge Funds and Analyst Conflicts of Interest

• In Event: Financial Analysts I

Abstract

Are sell-side analysts reluctant to go against the investment views of their hedge fund clients?
We show that analysts tend to upgrade stocks recently bought and downgrade stocks recently
sold by hedge funds. For stocks with favorable recommendations, post announcement
cumulative abnormal returns are significantly lower for those predominantly held by hedge
funds than for those eschewed by hedge funds. Investors do not appear to adjust for the bias
in analyst recommendations. Hedge funds take advantage of the price support conferred by
sympathetic analysts and trade concurrently against analyst recommendations. In line with an
agency-based explanation, our results are driven by important brokerage clients such as high
dollar turnover hedge funds, and hedge funds who prime with the analyst’s investment bank.
Analysts are more likely to issue upgrades and downgrades for stocks bought and sold by
their prime brokerage clients than for stocks traded by other hedge funds that are not prime
brokerage clients. Information-based explanations do not find support in the data.

Authors

• Sung Gon Chung, Singapore Management University

• Melvyn Teo, Singapore Management University