Research On The Causes Of Optimism In Financial Analysts’ Recommendations Under Bounded Rationality

Financial analysts are important information processors and disseminators in capital market, whose main responsibilities are collecting and analyzing useful data and information of listed companies using their professional knowledge, and then supplying stock recommendations and earning forecasts to investors in order to help them in their decision making. Contrary to their important roles, the financial analysts always have an optimistic tendency in their recommendations at present. This phenomenon will directly influence the investors’ value judgments and generate negative effects on investors’ benefits and resource allocation efficiency. Obviously, the premise of reducing the optimism is to find out the real causes. For this reason, based on the assumption of bounded rational economics, influence and acting mechanism of interest relation and cognitive bias on analysts’ optimism in their recommendations are explored. It tries to provide theoretical bedrock and empirical evidences to control of this tendency. The theoretical analysis and empirical study are combined organically in this paper and the causes of optimistic tendency in financial analysts’ recommendations are studied systematically. The detail research contents are as follows.1. Analysis of influence factors of optimism in analysts’ recommendations under bounded rationality. Based on the Asymmetric Information Theory and the Stakeholder Theory, the assumption of bounded rational economic man hypothesis is firstly put forward in this research. Under this assumption, as a bounded rational economic man, financial analyst is influenced by both cognitive bias and interest relationship. For the factor of cognitive bias when issuing stock recommendations, Four reasons that lead to cognitive bias emerging in analysts’ recommendations are pointed out, which are complexity of research target, immature development of analyst industry, imperfection of information disclosure system and unreasonableness in evaluation system. As for the factor of interest relationship, four interest relationships that analyst must face are discussed in this paper, which are relationships with his employing company, with institutional investor, with the management board of listed company, with himself and his relatives.2. Research on the formation mechanism of optimistic tendency in analysts’ recommendations under bounded rationality assumption. In this paper, the author systematically sorts out the mechanism of optimism tendency formation in analysts’ recommendations. First, the representative bias are taken as an examplethe to analyze the influence of cognitive bias on recommendations. Then, basing on the frame of Triangle theory, Cating theory and Prospect theory are applied to discuss the influence of interest relationship on recommendations from the aspects of pressure, excuse and rationalized explanation. Further, on the basis of clarifying the true meaning of analysts’ recommendation, the two ways to achieve optimism tendency for the financial analyst are pointed out, which are issuing precise rating and overestimating expected earning rate of stock. And then, three relevant theories (Four-Factor model, Cating theory, Reputation theory) are put to use to analyze the impact of cognitive bia and interest relationship on realization method of optimistic reommendation.3. Empirical test on the cause of optimism in analysts’ recommendations under bounded rationality assumption. In this step, the event study method is adopted to form a binary Logit regression model. Then, basing on the 21054 collected recommendation samples issued by Chinese financial analysts between 2010 to 2012, the influence factors of analysts’ optimism and their optimistic recommendations’ achieving methods are tested empirically. The results show that the optimism in recommendations is influenced by both the cognitive bias and the interest relation. The higher Cumulative Abnormal Return, the lower Book to Market Ratio and the higher Earning Rate on Net Assets of stock before recommendation, the existing of underwriting relationship, and the higher shareholding ratio by institutional investor that are shown in one stock, the higher probability of optimism can be seen in analysts’ recommendations on it. Among all the optimism ratings issued by analysts, most are shown as the overestimation of prospective earnings. Furthermore, the lower Book to Market Ratio, the higher Earning Rate on Net Assets and the higher shareholding ratio by institutional investor of one recommended stock exist in its features, the higher probability to reach or exceed analyst’s expectation can be found.4. Based on the drawing conclusions in this paper, some related suggestions are put forward by the author from three viewpoints including alleviating cognitive bias, weakening the interest relation with institutional investors and strengthening the supervision of analysts’ research behavior, in order to reduce their behavior bias and improve analysts’ professional practice level.