Security analysts' incentive and cognitive processing bias: evidence from analysts' recommendations

Ruei-Shian Wu and Hsiou-wei W. Lin

Asia-Pacific Journal of Accounting & Economics, 2014, vol. 21, issue 4, 443-471

Abstract: This study examines how incentive- and behavior-based variables affect analyst recommendation revisions. We use duration analysis to test analysts' underreaction to information by isolating the effects of incentives and cognitive processing biases on the timing of recommendation revisions. By controlling for favorable (unfavorable) preceding recommendations, we find that analysts delay conveying bad (good) news, which is consistent with the predictions of both the incentives and cognitive dissonance hypotheses (only the cognitive dissonance hypothesis). We also find that analysts delay responses to favorable information for outperformers with lower representative information, suggesting that analysts' underreaction to new favorable information is partially explained by the effect of psychological conservatism. Our results are robust after taking into account analyst affiliations, NASD Rule 2711 and SEC Rule 472, and market conditions.

Date: 2014
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DOI: 10.1080/16081625.2012.749776

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Asia-Pacific Journal of Accounting & Economics is currently edited by Yin-Wong Cheung, Hong Hwang, Jeong-Bon Kim, Shu-Hsing Li and Suresh Radhakrishnan

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