The Effects of Analyst‐Country Institutions on Biased Research: Evidence from Target Prices

• DOI: http://doi.org/10.1111/1475-679X.12245
• Author: ALAN G. HUANG,MARK T. BRADSHAW,HONGPING TAN
• Date: 01 March 2019
• Published date: 01 March 2019

DOI: 10.1111/1475-679X.12245

Journal of Accounting Research

Vol. 57 No. 1 March 2019

Printed in U.S.A.

The Effects of Analyst-Country

Institutions on Biased Research:

Evidence from Target Prices

MARK T. BRADSHAW,

∗ALAN G. HUANG,

†

AND HONGPING TAN

‡

Received 16 November 2015; accepted 11 June 2018

ABSTRACT

Prior research demonstrates that a strong institutional infrastructure in a

country moderates self-serving behavior of market participants. Cross-country

economic activities have increased significantly, presenting a research oppor-

tunity to examine the relative influence of local versus foreign institutional

infrastructure on individual market participants. We utilize variation in

analyst-country location relative to covered firm location to examine insti-

tutional determinants of optimism in analyst research. Focusing on target

∗Boston College; †University of Waterloo; ‡McGill University.

Accepted by Christian Leuz. An earlier version of this paper was circulated with the ti-

tle “Analyst Target Price Optimism around the World”. The authors gratefully acknowledge

helpful comments from an anonymous referee, conference participants at the 2012 Eastern

Finance Association meetings, the 2012 Northern Finance Association meetings, the 2013

FARS meetings, 2013 Midwest Finance Association conference, 2013 FMA Applied Finance

Conference (NYC), 2014 FMA Asian Conference (Tokyo), and from seminar participants at

Arizona State University, Baruch College, McGill University, University of Notre Dame, Ohio

State University, Temple University, University of Toronto, University of Waterloo,William &

Mary, Yale University, and York University. Authors H. Tan and A. G. Huang are grateful to

the Social Sciences and Humanities Research Council of Canada (grant Nos. 410-2011-2334,

435-2012-0752, and 435-2016-1164), and H. Tan is also grateful to the National Natural Sci-

ence Foundation of China (grant Nos. 71872154 and 71572047) and Key Projects of the Na-

tional Social Foundation of China (grant No. 16ZDA039) for financial support. Part of the

work was completed while H. Tan was visiting Jinan University and Southwest University of

Political Science & Law of China. An online appendix to this paper can be downloaded at

http://research.chicagobooth.edu/arc/journal-of-accounting-research/online-supplements.

85

CUniversity of Chicago on behalf of the Accounting Research Center,2018

86 M.T.BRADSHAW,A.G.HUANG,AND H.TAN

prices, where persistent optimism is well documented, we find that analysts

domiciled in countries with stronger institutional infrastructures exhibit sig-

nificantly attenuated target price optimism and more value-relevant target

prices. Our results demonstrate the importance of domestic country-level in-

stitutional factors in moderating self-serving behavior of market participants

engaged in cross-country activities.

JEL codes: G24; G30; K40; M16

Keywords: financial analyst; target price; optimism; analyst country; insti-

tutional infrastructure; investor protection; legal enforcement; self-serving

behavior; stock returns

1. Introduction

A country’s regulatory and institutional environment influences the behav-

iors of various market participants, including corporate insiders, bankers,

analysts, and investors. An extensive body of research using cross-country

settings examines the impact of regulation and institutional environment

on these market participants and observed features of different capital mar-

kets. These studies provide strong evidence that the institutional infrastruc-

ture of a country, investor protection and legal enforcement in particular,

moderates market participants’ self-serving behaviors (e.g., Leuz, Nanda,

and Wysocki [2003], Bushman and Piotroski [2006], Kadan et al. [2009],

Arand, Kerl, and Walter [2015]).

Increasing globalization of markets presents research opportunities to

examine how local relative to foreign institutions influence market partici-

pants engaged in cross-market activities. For example, analysts follow firms

from their own country as well as firms in other countries, and firms are

covered by analysts located in their own and other countries. These het-

erogeneous cross-country pairings of analysts and firms allow researchers

to more convincingly examine the influence of local institutions on ob-

served analyst behavior. Weemploy a firm-fixed effects structure that allows

us to control for firm-specific effects, including firm-country institutions,

and thus isolate analyst-country effects. This is not possible when examining

market participants independent of cross-country pairings (e.g., analysis of

firm-country effects while controlling for firm fixed effects).

In this study, we examine whether analysts are primarily responsive to

the rules and regulations of the countries in which they are domiciled,

rather than to those of the countries of their covered firms. To exam-

ine the influence of local institutions on analysts’ behavior, we examine

target price forecasts, which routinely exhibit optimistic bias (Bradshaw,

Richardson, and Sloan [2006]). This optimism is commonly attributed

to analysts’ conflicts of interest driven by investment banking and trad-

ing incentives (Lin and McNichols [1998], Irvine [2004]). We appeal to

this documented optimism as an ideal setting for investigating whether

effective institutional environments moderate such strategic, self-serving

THE EFFECTS OF ANALYST-COUNTRY INSTITUTIONS 87

optimism. Because machine-readable data on analysts’ geographic loca-

tions are unavailable, prior cross-country studies examining analysts’ earn-

ings and target price forecasts are conditioned on the institutional infras-

tructure of a covered firm’s home country, which is readily available. We

extend prior research by utilizing a large, hand-collected data set of ana-

lysts’ geographic locations to examine the association between the institu-

tional environment of an analyst’s domicile country and observed target

price optimism.

For each observation in our sample, we identify the country where the an-

alyst resides and the countries in which covered firms are headquartered.

Approximately 22% of target price forecasts in our sample reflect firms

headquartered in a country other than the analyst’s domicile country. As

an example of the importance of such cross-country activity, consider the

CFA Institute, which is the member organization for investment profession-

als who have obtained the Chartered Financial Analyst designation. As of

2018, there were 142,000 members across 159 countries. The CFA Institute

[2014, p. 14] promotes accountability, ethics, and integrity in the invest-

ment industry, and publishes standards and best practices for the increas-

ingly globalized capital market. An excerpt of those standards is as follows:

Some members or candidates may live, work, or provide investment ser-

vices to clients living in a country that has no law or regulation governing

a particular action or that has laws or regulations that differ from the re-

quirements of the Code and Standards. When applicable law and the Code

and Standards require different conduct, members and candidates must

follow the more strict of the applicable law or the Code and Standards.

“Applicable law” is the law that governs the member’s or candidate’s con-

duct. Which law applies will depend on the particular facts and circum-

stances of each case.

This standard of conduct suggests that various aspects of an analyst’s be-

havior may be subject to the rules applicable in both their home country

and the country where they provide services, which would almost certainly

include countries in which covered firms are headquartered.1If all analysts

were under the jurisdiction of the CFA Institute and adhered to its stan-

dards, then analysts would be subject to the more strict rules from either

the analyst’s country of residence or the country where a covered firm is

headquartered. However, not all analysts are subject to the CFA Institute

standards, and analysts who are may not necessarily adhere to them.

Additionally, anecdotal disclosures by individual brokerages highlight

the importance of identifying which institutions more effectively moderate

the optimism in analysts’ target prices. For example, in the United States,

1We have no way of determining where analysts provide services, so we rely on the existence

of a covered company to proxy for the likelihood that an analyst’s research is disseminated in

that local market.