Chinese Walls in German Banks ∗ Alfred Lehar

Analysts in a bank’s research department cover both, firms which have no relationship to the bank as well as companies in which the bank has a strategic interest. Officially, banks have to establish a Chinese Wall around the research department to allow the analysts to work independently and to avoid the flow of insider information. We examine long-term bank-firm relationships using ownership data and analysts’ earnings per share forecasts on German companies from 1994 to 2001. Our findings confirm two kinds of leakages through Chinese Walls. Firstly, forecasts from banks owning equity stakes convey superior information. Secondly, we find evidence of conflicts of interest, resulting in upwards biased reports. Analysts behave strategically, by using their information advantage mainly to release favorable reports in those times when the market underestimates earnings. In order not to jeopardize the bank-client relationship, they suppress negative information when the market is too optimistic. Despite the bias in analysts’ forecasts, they selectively communicate valuable information to investors. JEL Codes: G19, G21, G24