Financial Analysts Often Biased
December 19, 1997
The signs of a potential financial crisis in Korea and other Asian nations were evident before the bailout by the International Monetary Fund (IMF), but investors weren't alerted.
The reason: financial analysts are seldom rewarded for making sell recommendations and are often punished for doing so, say analysts. Negative ratings lead to threats of lawsuits, loss of business and other forms of intimidation.
- For instance, in 1990, Donald Trump was so incensed by a negative rating on one of his properties that he pressured the rating agency to fire the analyst who made the recommendation.
- It is common for analysts who make "sell" recommendations to find themselves ostracized by companies whose stocks they recommend selling.
- The financial analysts are often employed by brokerage houses or investment banks that do business with the offended companies; they risk losing loans or underwriting business that can be extremely profitable.
Brokerage houses and investment banks make most of their money on the "buy" side of the business; thus some 90 percent of all the recommendations made by financial analysts are to buy and only 10 percent to sell or hold.
Consequently, there tends to be an upward bias in financial analysis. This means that investors, including big institutional investors, are often getting poor advice and are left unprepared when bad news about earnings or other underlying problems can no longer be contained.
Source: Bruce Bartlett (senior fellow, National Center for Policy Analysis), December 17, 1997.
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