Accurate forecasts attract clients; Biased forecasts keep them happy

We examine whether business relationships between mutual funds and sell-side analysts influence earnings forecasts using Chinese data from 2007 to 2019. Consistent with prior studies, our results support the commission pressure hypothesis. Analysts' forecasts are overly optimistic for the holdings of existing fund clients. Significantly, we propose the potential client hypothesis and show that analysts' forecasts are more accurate for the holdings of funds that are not clients than for holdings of clients or for stocks not held by any fund. Our results suggest that commission pressure from existing fund clients increases analysts' optimistic bias, while potential clients pressure inhibits analysts' optimistic bias to some extent. Finally, our evidence supports the conflicts of interest hypothesis. Commission pressure is reduced as economic uncertainty grows.

Automated summary

This study examines the impact of business relationships between mutual funds and sell-side analysts on earnings forecasts. The findings suggest that analysts' forecasts are overly optimistic for existing fund clients, but more accurate for non-client funds. The study also reveals that commission pressure from existing clients increases analysts' optimistic bias, while potential client pressure partly inhibits the bias. Furthermore, the results support the conflicts of interest hypothesis, as commission pressure decreases with increasing economic uncertainty.