Sell Recommendations, Market Sentiment, and Analyst Credibility

We find that market reactions to an analyst’s earnings forecasts are weaker when conditioned on the number of prior sell recommendations that the analyst makes for other firms that he follows. This effect is most prominent in periods of high market sentiment (e.g., the 1997-2001 period) and is stronger for glamour firms. This effect does not arise from sell recommendations being a proxy for lower quality analysts. Our results are consistent with the idea that investors suffer from a behavioral bias, where optimistic investors assign lower credibility to analysts who make sell recommendations because such recommendations run counter to investors’ ex ante optimistic beliefs. Our results suggest that analysts may have been subject to a collective market pressure to hype stocks, and that those analysts that held contrarian views by issuing sell recommendations were likely to be sidelined. Consistent with this view, we find that analysts issue fewer sell recommendations when market sentiment is high. JEL Code: G19