The Impact of NASD Rule 2711 and NYSE Rule 472 on Analyst Behavior: The Strategic Timing of Recommendations Issued on Weekends

• Date: 01 July 2016
• DOI: http://doi.org/10.1111/jbfa.12211
• Author: Yi Dong,Nan Hu
• Published date: 01 July 2016

Journal of Business Finance & Accounting

Journal of Business Finance & Accounting, 43(7) & (8), 950–975, July/August 2016, 0306-686X

doi: 10.1111/jbfa.12211

The Impact of NASD Rule 2711 and NYSE

Rule 472 on Analyst Behavior: The

Strategic Timing of Recommendations

Issued on Weekends

YIDONG AND NAN HU∗

Abstract: Amendments to NASD Rule 2711 and NYSE Rule 472, enacted in May 2002, mandate

that sell-side analysts disclose the distribution of their security recommendations by buy, hold

and sell category. This regulation enhances the transparency of analysts’ information and

mitigates the long-recognized optimistic bias in their recommendations. However, we find that

analysts are more likely to issue sell recommendations or downgrade revisions on weekends

when investors have limited attention after these rule changes. This pattern is more pronounced

for prestigious analysts, who are more likely to influence stock prices. Market reaction tests reveal

an incomplete immediate response and a greater drift to unfavorable recommendations issued

on weekends. Finally, analysts who are more likely to release unfavorable recommendations

on weekends exhibit higher future forecast accuracy. Our findings suggest that, while these

regulatory changes effectively reduce analysts’ optimistic bias, they are also associated with an

increased prevalence of a different form of distortion in the capital market.

Keywords: analyst recommendations, limited attention, market inefficiency, weekend, NASD

Rule 2711, NYSE Rule 472

∗The first author is with the School of Accountancy, Shanghai University of Finance and Economics,

Shanghai, China. The second author is with the School of Business, Stevens Institute of Technology,

Hoboken, NJ, USA and School of Management, Xi’an Jiaotong University, Xi’an, China. The authors are

grateful to an anonymous reviewer and to Andrew Stark, the editor, for key suggestions. The authors also

thank reviewers from the Financial Management Association (FMA) 2013 Chicago conference, seminar

participants at Wayne State University, The University of New Hampshire, The University of Nottingham

Ningbo, The University of Akron, Stevens Institute of Technology, California State Northridge, Central

Finance and Economics University, and Elon University for their helpful comments. Yi Dong acknowledges

financial support from the National Natural Science Foundation of China (Grant Nos. 71402026, 71302076,

71502171) and MOE Project of Key Research Institute of Humanities and Social Science in University (No.

14JJD630010). (Paper received September 2014, revised revision accepted April 2016).

Address for correspondence: Yi Dong, School of Accountancy, Shanghai University of Finance and

Economics. Guoding Road 777, Shanghai, P.R.China, 200433.

e-mail: dong.yi@mail.shufe.edu.cn

Nan Hu, School of Business, Stevens Institute of Technology, Hoboken, NJ, USA.

e-mail: nhu4@stevens.edu

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1. INTRODUCTION

Serving as information intermediaries, financial analysts collect, process and generate

information that holds significant value to investors’ decision making. However,

their vital importance appears jeopardized by their distorted incentives to please

management in order to gain enhanced access to management-provided information.

Among the various types of information, private managerial information is one of the

most important in providing analysts with an informational advantage over their peers

(Schipper, 1991; Francis and Philbrick, 1993; Chen and Matsumoto, 2006; and Ke

and Yu, 2006). Although Regulation Fair Disclosure (Reg FD) intends to level the

playing field for capital market participants by constraining managers from disclosing

material information to selected analysts, Mayew (2008) shows that maintaining access

to management remains important for analysts after the passage of Reg FD.

The incentive to please management manifests itself in various forms. For example,

Francis and Phibrick (1993) show that analysts tend to report optimistic forecasts in

an effort to cultivate relationships with management. Chen and Matsumoto (2006)

subsequently demonstrate that analysts who issue favorable recommendations gain

enhanced access to management and exhibit higher future forecast accuracy than do

analysts who issue unfavorable recommendations. Similarly, Ke and Yu (2006) show

that to please firm management, analysts issue initial optimistic earnings forecasts

followed by pessimistic earnings forecasts. Therefore, analysts’ incentive to please the

management appears to create biases in their output. These biases have been shown

to exist in non-US countries as well, and to vary with institutional quality (Basu et al.,

1998; Hope, 2003; Barniv et al., 2010; Bradshaw et al., 2014; and Qi et al., 2014).

However, two regulatory reforms enacted in 2002 mandate analysts to improve the

transparency of their research and, in the process, implicitly force analysts to increase

their issuances of unfavorable recommendations. In May 2002, the self-regulatory

organizations NASD and NYSE in the US issued amendments to NASD Rule 2711

and NYSE Rule 472, respectively, on sell-side research. The amendments require

brokerage firms to disclose, in each research report, the percentage of securities

rated “buy”, “hold/neutral” or “sell” by their employed analysts. This regulation aims

to enhance the transparency of analysts’ output and to provide the capital market

with more valuable and reliable information (Securities and Exchange Commission,

2002).1Predictably, since the passage of the regulation, optimistic recommendations

have become less frequent, whereas pessimistic recommendations have become more

common (Barber et al., 2006; and Kadan et al., 2009). At first glance, enhanced

transparency by analysts appears to have reduced the bias in their recommendations.

It therefore becomes interesting and important to examine how analysts can release

more unfavorable recommendations without displeasing the management. In this

study, we propose and examine the following question: Do analysts strategically time the re-

lease of their unfavorable recommendations to give them on days when investors’ attention is low?

Constrained by limited attention, investors are likely to neglect value-relevant infor-

mation, particularly when they face more distractions over the weekend (DellaVigna

and Pollet, 2009). Issuing unfavorable recommendations at the weekend can spur a

less dramatic market response, while also allowing the analysts to report a reasonable

percentage of positive recommendations in the post-regulation period. By doing so,

1 Throughout the paper,the term “regulation” refers to the amended NASD Rule 2711 and NYSE Rule 472.

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