Inside the black box of financial analysts: what drives systematic forecast optimism?

Abstract

Despite past failures and a higher standard of regulation, excessive forecast optimism among financial analysts is still observable. It is mainly attributed to incentives provided by an underlying affiliated relationship. This paper investigates diverse market settings in the Thai stock market between 2005 and 2017 to break down the incentive structure in the analysts' forecasting process. First, banks and brokerage houses with an affiliated mutual fund family show an extreme forecast behavior, especially when the fund family is backed by high capital and has a large stake in the covered firm. Secondly, full-service banks are among the most optimistic analysts in the market, particularly when they act as a lead underwriter during an IPO. However, lead underwriters tend to revert optimism to average level one year after the equity issuance. Banks acting as share distributors during an IPO are not necessarily more optimistic than the analysts' general favorable level of optimism. The paper concludes that the pressure for banks and brokerage houses to generate trading, enhance deal flows, and favor the management of the covered company impacts the forecasting behavior of individual analysts.