Changes in analysts’ stock recommendations following regulatory action against their brokerage

Despite the importance of sell-side analysts in the capital markets, we know little about the effectiveness of routine monitoring of the sell-side industry. We examine the attributes of sell-side research issued by analysts before and after their brokerage faces regulatory sanctions. We find that after a sanction, analysts at sanctioned brokerages lower their stock recommendations, both in absolute terms and relative to the recommendations of other analysts following the same firms. These analysts are also more likely than analysts at other brokerages to downgrade a company’s stock after the receipt of unfavorable information about the firm. Importantly, we document that analysts at nonsanctioned brokerages also reduce the optimism of their stock recommendations when a peer analyst’s brokerage is sanctioned, consistent with spillovers as a result of routine regulatory monitoring. Our study provides evidence that regulatory action against sell-side brokerages is associated with a reduction in sell-side analysts’ positive bias.