Self-Selection and Analyst Coverage

This paper examines the relation between analysts’ information about a stock’s future prospects and their decisions to issue investment recommendations and earnings forecasts for that stock, and the implications of this relation for the observed distribution of recommendations and earnings forecast errors. Articles in the financial press have long argued that analysts are reluctant to issue unfavorable investment information, perhaps because they fear jeopardizing potential investment banking business;1 they fear losing access to management as a source of information;2 and/or they seek to generate trading commissions.3 To date, the academic literature has generally suggested that these forces cause analysts to bias their true predictions toward a more optimistic view. We examine an alternative response to disincentives to disclose negative information, that analysts are more likely to provide forecasts and recommendations for stocks about which their true expectations are favorable.