Spillover Effects of a Change in Analyst Reputation with Investors? Evidence from Analyst Recommendations for Misstatement Firms

• In Event: Financial Analysts and the Capital Market

Abstract

We examine whether an analyst’s single research output affects investors’ perception of his research for other firms in his portfolio (i.e., spillover effects). Our tests use financial misstatements as a setting where the misstatement revelation represents a shock to the reputation of analysts who followed the misstatement firm. For bullish analysts, we find that the reputation loss stemming from recommending the misstatement firm weakens investors’ reaction to the earnings forecast revisions by the same analyst for non-misstatement firms in his portfolio (i.e., negative spillovers). Conversely, we find evidence of positive spillovers for bearish analysts, consistent with a reputation gain for these analysts. These spillover effects manifest not only in earnings forecast revisions, but also in stock recommendation revisions for non-misstatement firms. In subsample analyses, we find that the spillovers are concentrated in situations when investors’ prior about the analyst is imprecise, presumably because the new information from the misstatement revelation is particularly impactful in these situations. Also, the spillovers are concentrated in situations when additional information about the analyst’s work on the misstatement firm corroborates the signal from the misstatement revelation. Overall, we provide new evidence on the dynamic process through which analysts gain or lose their reputation with investors.

Authors

• Lian-Fen Lee, Boston College

• Alvis K. Lo, Boston College