What is meant by financial analyst

Financial research - how objective and independent are the forecasts made by financial analysts actually?

Table of Contents

List of figures

List of tables

List of abbreviations

1 Introduction
1.1 Problem
1.2 Objective and structure of the work

2 The role of financial analysts in the capital market
2.1 Basic characterization of financial analysts
2.1.1 Definition and demarcation of financial analysts
2.1.2 Classification of financial analysts
2.2 Functions and goals in the capital market
2.2.1 Analysts as information intermediaries
2.2.2 Functions of financial analysts from an economic point of view
2.2.2.1 Information efficiency
2.2.2.2 Process efficiency
2.2.2.3 Reduction of agency problems
2.3 Tasks and contents of the financial analyst activity
2.3.1 Organizational classification in the banks
2.3.2 Financial research methodology
2.3.3 The financial research process
2.3.3.1 Obtaining information
2.3.3.2 Information processing
2.3.3.3 Information Distribution

3 factors influencing the quality of financial research
3.1 Empirical findings on the recommendations and forecasts
3.1.1 Price reaction on publication
3.1.2 Over-optimism
3.2 Behavioral influencing factors
3.2.1 Behavioral Finance
3.2.2 Behavioral anomalies and heuristics
3.3 Conflicts of Interest
3.3.1 Conflicts of Interest Due to Business Relationships
3.3.1.1 In-house relationships
3.3.1.2 Management relationships
3.3.2 Personal Interests and Goals of Financial Analysts
3.3.2.1 Success-oriented goals
3.3.2.2 Own shares and mandate activities
3.3.3 External influences
3.4 Specific influencing factors
3.4.1 Analyst and employer-specific factors
3.4.2 Company-specific factors
3.5. Regulation of analyst activity
3.5.1 Voluntary self-regulation
3.5.2 Legal Regulation
3.6 Summary

4 Analysis of analyst assessments in the period from November 2007 to January 2008
4.1 Situation on the German stock market
4.2 Empirical examination of the forecasts and recommendations
4.2.1 Database
4.2.2 Examination of share recommendations and price forecasts
4.3 Assessment of the results
4.4 Developments in financial research

5 Summary and Outlook

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List of figures

Figure 1: Information flows relevant to valuation on the capital market

Figure 2: Levels of information efficiency according to Fama

Figure 3: Classification of research in the field of activity of a bank

Figure 4: Examples of trend lines in technical analysis

Figure 5: Examples of formations in technical analysis

Figure 6: Information activities of the financial analyst

Figure 7: Research methods

Figure 8: Subjective evaluation of price changes

Figure 9: Price reaction to price-relevant positive information

Figure 10: Stakeholder groups of the sell side analysts

Figure 11: Target system of the sell side analysts

Figure 12: Development of the M3 money supply in the euro area

Figure 13: Development of key interest rates in the USA and Euroland

Figure 14: Ifo world economic climate

Figure 15: Consumer price index for Germany

Figure 16: Contributions to growth in real gross domestic product

Figure 17: ZEW business cycle indicator

Figure 18: Ifo business climate index for Germany

Figure 19: Development of the DAX in 2007

Figure 20: Development of the MDAX in 2007

Figure 21: Analyst forecasts for the DAX at the end of 2008

Figure 22: Development of the DAX between November 2007 and January 2008

Figure 23: MDAX development between September 2007 and January 2008

Figure 24: Number of recommendations (observation period and comparison periods)

Figure 25: Absolute distribution of recommendations (November 2005 to January 2006)

Figure 26: Absolute distribution of the recommendations (November 2006 to January 2007)

Figure 27: Absolute distribution of the recommendations (November 2007 to January 2008

Figure 28: Relative distribution of the recommendations (November 2005 to January 2006)

Figure 29: Relative distribution of the recommendations (November 2006 to January 2007)

Figure 30: Relative distribution of the recommendation (November 2007 to January 2008

Figure 31: Distribution of the recommendation categories Buy and Hold / Sell (November 2005 to January 2006)

Figure 32: Distribution of the recommendation categories Buy and Hold / Sell (November 2007 to January 2008)

Figure 33: Histogram

Figure 34: Number of price target adjustments (November 2007 to January 2008)

Figure 35: Relative distribution of price target adjustments (November 2007 to January 2008)

Figure 36: Times of price target adjustments in January 2008

List of tables:

Table 1: Assessment categories and their meaning

Table 2: Information Perception Anomalies

Table 3: Information processing anomalies

Table 4: Decision anomalies

Table 5: Investigated banks and analyst firms

List of abbreviations

Figure not included in this excerpt

1 Introduction

1.1 Problem

“On the stock exchange, two times two is always five minus one,” said Bonmot Andre Kostolany once, describing how difficult it is to forecast developments on the capital markets.12 Capital market players who deal professionally with the preparation of these forecasts are referred to as financial analysts. As part of their work, they create forecasts and share recommendations for listed companies and try to show their future developments. Their task is in particular to uncover mispricing of stocks or companies and then to convert them into appropriate recommendations for action for investors. In their role as information intermediaries, they make an important contribution to the functionality of the capital markets. However, they will only fulfill their function in the capital markets if they carry out stock research that is as objective and independent as possible. After the capital market bubble burst at the end of the 1990s, however, there were considerable doubts as to whether the prerequisites were actually always met. Up until March 2000, the international capital markets were characterized by a long-term upward trend. The positive development in the markets meant that investors hardly questioned the work of the analysts critically, despite their far too optimistic forecasts and recommendations. However, when the share prices began to show increased losses from March 2000 and the capital market bubble burst, the analysts came under increasing criticism. Among other things, they were accused of having driven the rapid rise in the capital markets through far too optimistic forecasts and recommendations. Critics also argue that this extreme over-optimism of the analysts would have contributed to ill-considered security purchases on the part of investors, which ultimately caused the rapid rise in prices, without which this would have been fundamentally justified. In addition, analysts came under fire in various accounting scandals such as Worldcom or Enron. Some analysts advised to buy shares just a few days before Worldcom went bankrupt. After these obvious problems with these analysts' assessments, a number of legal and professional regulations were issued, in particular to counteract the conflicts of interest often cited as the main reason for this over-optimism and ultimately to regain the confidence of investors. However, it is questionable whether these measures can prevent the conflicts of interest and the over-optimism of the analysts. Therefore, the role of analysts in the development of the German stock market between November 2007 and January 2008 is to be examined in the present work.

1.2 Objective and structure of the work

The aim of the present work is to show, on the one hand, how objective and independent the forecasts and recommendations of financial analysts can be. For this purpose, the most important influencing factors that can affect the quality of financial research are theoretically identified and described. In addition, the empirical study shows that the behavior and role of analysts in the development of the German stock market between November 2007 and January 2008. The structure of the following work results from these considerations. This work is therefore subdivided into 4 chapters in addition to the introduction.

First, Chapter 2 describes the role of financial analysts in the capital market from a theoretical point of view. The term financial analyst is defined and the financial analysts are classified. This is followed by an explanation of their functions on the capital market, which they perform or should perform from a theoretical point of view. The various analysis methods and the financial analysis process are then described by analysts as part of the provision of services. Chapter 3 deals with the possible influencing factors on the quality of the forecasts and recommendations. First, the empirical findings on market reactions and the over-optimism of recommendations and forecasts are presented. Subsequently, the influencing factors are described which may influence the quality of the research and which can justify increased optimism. Behavioral aspects, conflicts of interest and specific influencing factors are identified and discussed. The end of the chapter describes the current developments in relation to the legal and professional changes that have a direct effect on the analysts' activities. Chapter 4 presents our own empirical study of the published analyst assessments on the German stock market. It extends over the period from November 2007 to January 2008. First, the fundamental framework factors and the development of the German stock market in the period under review are presented. The subsequent investigation checks the recommendations and prognoses for a possible over-optimism. In addition, the question is clarified whether the analysts had a decisive influence on the development of the German stock market during this period. After assessing the results, the opportunities for further development and current trends in financial research are shown. The main results and findings of the theoretical and empirical analysis of this work are summarized in Chapter 5.

2 The role of financial analysts in the capital market

2.1 Basic characterization of the financial analyst

2.1.1 Definition and demarcation of financial analysts

Financial analysts are often referred to as investment or securities analysts and belong to the group of information intermediaries. Your basic task consists of the procurement, checking, processing, interpretation and the strategic classification of generally available information and special prior knowledge in order to be able to create forecasts and recommendations for companies based on this. These in turn serve other capital market participants as a basis for future investment decisions.

According to the definition of the German Association for Financial Analysis and Asset Management (DVFA), financial analysts are people "who, based on generally available information and special prior knowledge, assess and evaluate the securities of companies and their derivatives - including economies, capital markets and industries - in the form of mostly carry out written analyzes. The results of the work of the analysts serve private and institutional investors and customer advisors, asset managers and portfolio managers in capital investment companies in Germany and abroad as a basis for investment decisions. "3

Financial analysts are to be distinguished from financial journalists who work for a wide variety of stock market information services such as stock market letters, investment magazines or broadcasters. The financial journalists process both direct company news and research reports on companies, as well as information they have researched themselves.4 These results are then published by them in the various media. The overriding goal of the journalists is not only to improve their personal reputation, but also to increase the number of copies and the audience rating of the respective medium.5

The so-called "gurus" or "tipsters" are another group that is difficult to distinguish from financial analysts and to classify. This means people who are in public and can develop such an intense effect that they are able to move share prices with lower trading volumes through their recommendations. The gurus come to a lesser extent from the group of analysts, but to a far greater extent from the group of journalists. The main problem here is the combination of journalism with high-profile television appearances and a simultaneous engagement as an asset manager. Mass psychological mechanisms can lead to substantial and fundamentally unjustified price movements that could be exploited profitably. This is particularly problematic if, in advance of the publication of the report, corresponding positions were established by these actors.67 Since the present work focuses specifically on the services of financial analysts, it is essential to clearly distinguish the subgroup of financial analysts from the other subgroups of financial journalists and the so-called "tipsters".

2.1.2 Classification of financial analysts

Financial analysts can be differentiated based on their institutional dimension. The institutional dimension differentiates between (1) sell side analysts and (2) buy side analysts.

(1) The sell side analysts work in the research departments of investment or universal banks as well as brokerage houses and offer their services primarily to external customer groups. The primary goal is to address your own customers as well as to win new customers in order to support your own sales department. The research is either passed on directly to the customers or published via the journalists or the information service providers. It should be noted that the general public often receives this information with a delay, as the paying customers are first served with the reports and recommendations. For the credit institute, which usually bears the costs for sell-side research, such a department only makes sense if the costs incurred are offset by additional income. This additional income can be generated by selling the reports, increasing trading volume and increasing awareness of the research department.

(2) In contrast to the sell-side analysts, the buy-side analysts are usually employed by institutional investors, for example by capital investment companies, insurance companies or credit institutions. You create reports, studies and investment assessments exclusively for your own company. The information provided flows directly into the investment decision and supports their respective portfolio managers in assessing industries and individual companies. Institutional investors with their own buy-side research finance these departments mostly through better investment success or by optimizing the performance of their investments. In addition to the institutional analysts, there is a group of analysts who cannot be clearly assigned. This is the group of independent analysts that has grown in importance over the past few years. The largest and most important independent analyst firms in Germany include Independent Research, Equinet, SES Research and AC Research. In contrast to the buy side analysts and the sell side analysts, these do not work for an investment bank or for institutional investors, but they are independent and provide investors with their independent financial analyzes for a corresponding fee. They mostly sell their research reports on a subscription basis or as project work. The target group is mostly a small, wealthy group of private and institutional investors. Although these analyst firms are ascribed a high degree of objectivity and independence, they are also very much dependent on good relationships and contacts with company management and, in particular, with the customers of their commissioned studies. These, in turn, can be reasons that call into question the complete independence of these analyst firms.89

The institutional analysts differ in their goals and research activities. The sell-side analysts initially do not generate any direct revenue for their reports and are therefore subject to a particular conflict. On the one hand, they should produce research that is as undistorted as possible in order to fulfill their function as an information intermediary. On the other hand, there is a risk that the objectives of their employers with regard to the acquisition of new customers and the increase in trading volume will outweigh the common assumptions.However, such conflicts between the buy side analysts and the portfolio managers are hardly to be expected, since the research report is not passed on to the outside world.10

In particular, the sell-side analysts are the focus of public discussions when it comes to misjudgments of certain companies and the associated conflicts of interest. For this reason, the author examines the group of sell side analysts for possible conflicts of interest in the following work.

2.2 Functions and goals in the capital market

2.2.1 Analysts as information intermediaries

Capital markets are the coordination points in order to bring together monetary dispositions of capital providers and capital seekers and to direct capital to its most efficient possible use. The securities market represents a sub-area of ​​the capital market in which the brokerage of capital is coordinated in a securitized form.1112 In the following, the services of the financial analysts are examined, which relate to the securities market as part of the capital market. These capital markets are characterized by processes of information perception, processing and transfer, which show the result of an information competition between all market participants. The information communicated in this market represents purpose-oriented knowledge, for example in the form of messages about the probability with which a certain event can occur. Thus, messages that cause price changes indicate security information. Figure 1 shows the various players on the capital markets. The two main actors are, on the one hand, the entrepreneurs, who act as buyers of capital and, on the other hand, the investors, who act as capital providers. The entrepreneurs need capital to make their necessary investments. Investors are ready to make this available, provided they can achieve a correspondingly high return. However, in this constellation there is an asymmetrical distribution of information. Companies have a decisive information advantage over investors with regard to their own future development potential and possible risks associated with an investment. In order for a capital transfer to take place anyway, information about the company must be produced and made available both by the company and by third parties. The specialists in collecting, evaluating and communicating information are referred to in the literature as information intermediaries. They can be defined as "intermediaries who are involved in an exchange of financing instruments in order to overcome or alleviate the information barriers between borrowers and lenders resulting from an asymmetrical distribution of information."1314 The information intermediaries represent the third group in addition to investors and companies in the market for securities information. They are the link between the source of information, the company and the investor and at the same time serve as a channel for information relevant to valuation. This information is bundled by them and processed by means of appropriate analyzes. Because of this information processing, there is no pure information trade, but information intermediation. The analyzes and recommendations they create are usually based on publicly available information as well as job-specific knowledge and are the result of a complex information and processing process. They serve both private and institutional investors as the basis for their investment decisions.15

Figure 1 shows that the company requesting capital has different ways and means of transferring information. The news flows to three target groups from the company, the main source of information relevant to the rating. This takes place on the one hand through direct communication with the investors and on the other hand through indirect communication via intermediary information intermediaries. In addition to the media, financial analysts can be assigned to the group of information intermediaries. They serve as information agents between the company and the investor. The internal company information transmitted to the capital market is on the one hand required by law and on the other hand it is published on a voluntary basis. In particular, the voluntary publicity represents a strategically planned and targeted communication between the company and the investors and the information intermediaries, the so-called "financial community". This strategically planned and targeted communication is called investor relation. With the support of investor relations measures, the company's strategy is translated into the language of the financial community in order to make the actual value potential of the company clear to capital market participants and to positively influence their expectations.16 The overriding goals are the reduction of the cost of capital and an appropriate long-term valuation on the capital market, which reflects the company's actual earning power and actual risk.17

A significant part of the flow of information on the capital market takes place through the interposition of information intermediaries. This suggests that financial analysts can add value for both companies and investors. Exactly where this added value lies and how the existence of the analysts is theoretically justified is the content of the following section.

2.2.2 Functions of analysts from an economic point of view

The essential prerequisites for a functioning capital market are the availability of undistorted information, a broad base of investors with access to this information, laws that protect the rights of investors and a liquid and efficient secondary market. For analysts, the availability of undistorted information and the availability of a liquid and efficient secondary market are particularly crucial.

In order to examine the effects of the analysts with regard to their analyzes, recommendations and forecasts on the efficiency of the capital market, the use of the concepts of information and procedural efficiency is recommended. Optimal allocation efficiency can only be achieved if there is optimal information and procedural efficiency on a capital market. In the following, the influence of an effective and efficient financial analysis with regard to information and procedural efficiency will be examined. In addition, the problems that result from incomplete contractual relationships and the separation of ownership and control are addressed in the framework of the agency theory.

2.2.2.1 Information efficiency

In an efficient capital market, the future share price depends only on the information occurring in the future and can therefore not be forecast rationally. The right to exist of financial analysts is therefore directly related to the theory of the information efficiency of capital markets. Fama (1970) lays the basis for the theory of information efficiency with his definition of an efficient market: "A market in which prices always' fully reflect" available information is called. "The conditions for this theory are that the market participants have all available information at all times are available free of charge, there are no transaction costs and there are homogeneous expectations regarding the interpretation of information by market participants.18

In the information-efficient markets, all information is processed immediately and the prices of the traded securities contain the information relevant to the valuation at all times. There are course changes when "new" information arises that could not be foreseen on the basis of previous information.19 The incorporation or processing of new information takes place immediately and without any delay. The price of a security is therefore the best estimate of its intrinsic value at any point in time and is therefore a reliable indicator of value and a point of reference for the investment decision. Depending on the relevant information available for the valuation of an asset, Fama differentiates between three types of information efficiency: the weak Form, the semi-strict form as well as the strict form.20

Figure 2 shows that every higher form of information efficiency includes the lower form. There is poor information efficiency on the capital market when all information about historical price developments is contained in the current price of a security. If publicly available information about the historical price development, i.e. all information made known through publications, flows directly into the prices of the securities, then there is a semi-strict information efficiency. In contrast, a market is strictly information-efficient if the security prices contain all information relevant to the valuation. The pool of information thus includes not only historical prices and publicly available information, but also what is known as insider information. Only in a strictly information-efficient market is there an optimal transfer of capital to its best possible use. If all information relevant to the valuation is fully and immediately priced into the market price, the price mechanism is completely intact. However, in a strictly information-efficient market, the existence of financial analysts is of no use, since financial analysts should not be trading and tracking down inside information.

Furthermore, financial analysts will not be able to achieve excess returns in markets with semi-strict information efficiency, since the publicly available information is immediately priced in and the preparation of analyzes amounts to an overproduction of the knowledge already available on the market. If this production is also associated with costs, there will be a decline in overall economic welfare. However, there is a logical deficit. How does a share trade come about when in an information-efficient market no individual can achieve excess returns through information gathering and information processing? For what reason should expensive information be bought or produced if it does not add any value? If there are no incentives for any information activity, then it will not be possible for all information to be reflected in market prices. This condition described and examined by Grossman / Stiglitz (1980) is called the information paradox.

In reality, there are market imperfections which, due to behavioral anomalies or individual decision heuristics, lead to a suboptimal information processing process. If the behavior of the market participants is emotionally bound or if mass psychological aspects, such as herd behavior, influence price formation, then the information efficiency of the capital market is limited. This results in various conditions on the capital market, such as speculative bubbles and overreactions, etc., which can only very rarely be explained rationally. In addition, there is an at least temporarily inefficient market, assuming strict information efficiency, if there are costs for information search and information evaluation, legal restrictions exist, the use and procurement of information is restricted and the market participants212223 see the pricing system available on the market as completely informative. The Grossmann / Stieglitz model envisages the introduction of costs for information acquisition, whereby the extent of the associated decision-making improvement influences the value of the information. The capital market participants will only obtain information if the marginal utility is greater than the marginal costs incurred. Otherwise the information will not be obtained and the information will not be incorporated into the prices. Even if the information were available free of charge, investors must have the necessary knowledge, skills and resources to be able to evaluate and process the information in an unbiased manner. If the control of these factors is in turn associated with costs, this can also lead to inefficient information processing, even if the information were available on the market free of charge. This problem can be solved by the work of financial analysts, since they have the knowledge and resources to secure or increase the information efficiency in the capital markets. As part of their intermediation function, they can generate economies of scale as well as advantages of specialization in order to reduce the overall information costs. It follows that financial analysts only exist in the capital markets when the market is inefficient and deviates from a perfect market. With their rational and undistorted forecasts and recommendations, they enable an increase in information efficiency and thus provide added value for the capital market. The first function of the financial analyst can be derived from this knowledge.

2.2.2.2 Process efficiency

A variant for measuring procedural efficiency in the capital markets represents efficiency as the sum of the following four cost components determined by the market organization: 1. the costs of the bank's securities service, 2. the costs of ongoing information, 3. the transaction costs and 4. the administration and custody costs . The production of these services takes place with the most efficient process and in competition with the services of the providers. The aim is to minimize the sum of the individual cost components and thus to increase the degree of process efficiency.242526 When examining the contribution of financial analysts to procedural efficiency, the transaction costs are a decisive factor. For investors, the amount of the transaction costs has a direct influence on the demand for securities and the yield to be achieved. The lower the transaction costs for the investor, the higher the return that can be achieved. In some cases, certain cost components are affected at the same time, so these can lead to opposite effects. For this reason, it makes sense to combine these into three independent subgroups: 1. the information and decision-making area, 2. the execution area, and 3. the fulfillment and custody area. The activities of financial analysts and the associated procedural efficiency relate primarily to the information and decision-making area. This area includes the costs incurred by investors for ongoing information, the transaction-related information and decision-making costs, the costs of safeguarding against information risks and the costs of the issuer for the mandatory provision of information in the context of periodic publicity.27

When investors make a decision regarding the purchase or sale of a security, not only the individual preferences and criteria but also the information about alternative courses of action and factors influencing the result are decisive. In addition to the legal guidelines of the stock exchange and financial news, this also includes the forecasts and recommendations of the financial analysts. If there is a correspondingly large number of financial analysts on the market and there is correspondingly functioning competition between them, the costs for the information and decision-making area will decrease. By communicating precise, undistorted forecasts and recommendations, investors can now minimize their transaction-related information and decision-making costs as well as the costs of securing against information risks. Investors can lower their costs through the existence of the analysts, which has a positive effect on their returns. Creating the forecasts yourself would be associated with much higher costs, since you cannot benefit to the same extent from the effects of size and specialization when processing information. On the other hand, there are negative effects if the forecasts and recommendations made by the analysts are incomplete or incorrect. For example, incorrect company reports, analyzes or forecasts can lead to financial disadvantages for investors. Even if the quality of the equity research is not reliable, the investor will include this information in his investment decision and protect himself against the possible risk of financial disadvantages by means of a kind of self-insurance. This results in additional expenses for hedging and consequently higher imputed transaction costs. These in turn have a negative effect on the return that can be achieved, resulting in higher capital costs for the company.The increased risks make it more difficult to obtain liquidity and lead to higher returns on the part of investors. It is therefore necessary to achieve the highest possible degree of procedural efficiency on the capital market, because only then can a correspondingly high information efficiency be achieved. The decisive factor here is that new information is only priced into the security prices through the buy or sell decisions of the investors. But investors only invest when the expected profits exceed the transaction costs incurred. If this is not the case, the necessary investments will not be made and the new information cannot be priced into the courses. For this reason, the courses do not reflect the actual level of information and are of inferior quality. Therefore, high transaction costs have an inhibiting effect and prevent the corresponding price adjustment mechanisms in the courses, which are, however, necessary in order to achieve the highest possible level of information efficiency. Finally, it emerges that procedural efficiency is a necessary condition for information efficiency in order to achieve high allocation efficiency in the markets. This enables analysts to contribute to research that is as objective and undistorted as possible.

2.2.2.3 Reduction of agency problems

Agency relationships exist wherever a person (principal) commissions another person (agent) to provide services in the interests of the principal, with parts of the decision-making authority being transferred to the agent. In the case of listed stock corporations, such an agency relationship exists between the equity capital provider (principal) and company management (agent).

The shareholders, as the owners of the company, provide their capital in return for future payments and delegate the management to the management. The employed managers decide on the use of the resources and thus influence the profit claim of the investors. By separating equity capital and management power of disposal, risks can be reduced, since capital is provided by a large number of shareholders, and this is done on a broad basis28

Allows diversification of the entrepreneurial risk. In addition, managers with their qualifications and the corresponding knowledge can use the invested capital much more efficiently and in a more targeted manner.29 The problem with this relationship is the existing conflicts of interest between the equity investors and management. There is a different level of information between the two parties. The managers have an information advantage over the investors with regard to the company's development and future potential for success. However, it is precisely this information that is crucial for the equity investor to calculate the return. Due to the different information levels of both parties, this condition is known as asymmetrical information distribution.30

The agency theory differentiates the information asymmetries resulting from the division of labor with regard to their development phase, on the one hand, before the conclusion of a contract (hidden information) and, on the other hand, after the conclusion of a contract (hidden action).31 Before entering into a contractual relationship, potential equity investors (principals) run the risk of not being able to adequately assess the actual quality of a company due to their lack of information. The shareholders must expect that the company value will be presented more positively than it actually is in order to achieve a much higher share price. Therefore, investors will use a rating that is based on the average quality of all companies and they will therefore only pay a correspondingly low average price. From this it follows that all agents leave the market who offer good or better quality than average and only companies with lower quality remain in the market (adverse selection). Higher quality companies (undervalued companies) will therefore meet their capital requirements primarily through internal financing, such as retained earnings. In contrast, companies of inferior quality (overvalued companies) obtain their liquidity requirements mainly from the capital market. The average quality on the market will then continue to decline and rationally acting investors will increasingly reduce their willingness to invest. As a result of the lack of balance between price and quality, in extreme cases there is no capital provision by investors. Market failure occurs.

The problem after the conclusion of the contract is that the management uses the information advantage to maximize its own benefit (moral hazard). Less labor or the use of resources for one's own interests are possible manifestations of such behavior. There is a risk that investors' capital will not be put to its most efficient use and that resources will be wasted. In order to counteract the dangers of moral hazard and adverse selection, it is important to design appropriate contractual or financing relationships, whereby these problems can be overcome or at least an extensive harmonization of interests can be achieved. Before signing a contract, investors could analyze the company in more detail (screening). After the provision of capital, measures such as the establishment of rules of conduct, the setting of incentives (remuneration systems) and control of the company management through the procurement of appropriate information (monitoring) would be conceivable. However, these measures are in turn associated with very high agency costs and ultimately do not lead to a complete resolution of these conflicts.

By engaging financial analysts as information intermediaries, information asymmetries can be reduced by regular management monitoring for investors. If management is monitored by each individual equity investor, the agency costs are very high. According to Diamond, the monitoring and delegation costs of the financial analysts, the so-called "delegated monitors", are lower overall than those of alternative monitoring by a large number of individual investors. They have the great advantage of obtaining the information at a much lower cost than the individual investors, as they have the necessary knowledge, the relevant industry knowledge and the necessary experience to filter out and process important from unimportant company information. You can also incorporate this information and experience into analyzing the same or similar companies. They represent a suitable contact person for every investor with regard to company-specific issues and, as independent experts, make a very important contribution to the assessment and evaluation of the information obtained. Financial analysts can exert influence on company management through their specialist knowledge, experience and public effectiveness (monitoring). Through published research reports in which weaknesses in corporate strategy or negative management behavior are uncovered, analysts can put pressure on the company and indi-32 exert a direct influence on management. In this way, analysts, in cooperation with the market, are in principle able to discipline management in the interests of equity providers and can thus make a contribution to the external33 Corporate control, corporate governance.

Due to the existence of financial analysts, on the one hand the agency costs are significantly lower and this results in a higher company value. Thus, the financial analysts have cost advantages when monitoring corporate management. As a result, observation by analysts is also a desirable goal from the company's point of view. On the other hand, the analysts cannot be confirmed to have acted completely selflessly in terms of guaranteeing capital market efficiency and corporate control. Rather, their behavior is often influenced by their own career planning, salaries and a certain loyalty to their employers. As benefit maximizers, analysts will always take care not to violate the interests of their own employer, but at the same time to maximize their own target function. These multilevel principal-agent relationships are important determinants of research quality and are the focus of chapter 3.

2.3 Tasks and contents of the financial analyst activity

2.3.1 Organizational classification in the banks

Financial analysts conduct research, which means they systematically analyze factors that determine value and share prices and assess markets, sectors or individual companies in the form of specially prepared research studies. A research study - hereinafter also referred to as research, research report, study or financial analysis - is a written or electronic communication and contains an analysis of the instruments traded on the capital markets, their issuers and a corresponding investment recommendation. The aim of the research is to be able to more reliably assess the future developments and potentials of the objects of analysis. In this context, the term coverage or analyst coverage is often used. This designation represents the processing of a specific market segment or specific company by research or an analyst.343536 The target groups of the research services include not only the company's own customers, but also the bank's internal business areas and their customers, external banks and institutional investors. As part of the public relations work of banks, these studies are also offered to non-customers free of charge or for a corresponding fee. Banks organize their research very differently, with three basic forms having emerged.

(1) On the one hand, this is the most common centralized in-house research found in investment and universal banks. All research tasks are concentrated in a single department. This central organization enables immediate business support for a large number of activities in the individual business areas and represents an essential component of the value chain in banks (see Fig. 3). Nevertheless, the research does not illustrate a business field in the narrower sense, as it does not generate its own turnover. Instead, through its activities, it makes a significant contribution to the development of sales in the business units. Research reports are usually made available to investors free of charge. However, payment for the research is made indirectly through the fees for the securities transactions carried out. From a purely economic point of view, centralized in-house research is a sensible option, but the research must meet the needs of a large number of customers with the most varied of needs. In addition, such extensive and complex organizational integration of research in banks harbors the risk that analysts in particular are exposed to numerous external influencing factors, which lead to the frequently criticized conflicts of interest.

(2) Another possibility is the spin-off of research into an independent subsidiary, the so-called outsourcing or independent research. In this case, the research department is outsourced to a legally independent subsidiary and can evade direct influence through banking interests. The focus is clearly on competition and customer orientation. In addition to the difficult task of obtaining adequate prices for the services on the market for your research reports, you are in direct competition with the reports that are often available free of charge. This variant harbors the risk that the research subsidiary cannot meet all the requirements of the internal business areas and that individual business units can thus set up their own research, which results in duplication of work and losses in efficiency.

(3) The third variant of organizing a research department in the banks is hiring37

decentrally integrated in-house research. Here, the focus is on covering the range of tasks of the various internal business areas.38 Each central unit has its own individually tailored and function-specific research area. Only basic research is set up centrally, which creates the overall economic assessments and makes them available to all other departments. This enables an optimal coordination between supply and demand. However, such decentralization makes problem-free internal coordination between the individual areas more difficult, for example when sharing databases. Departmental boundaries can also prevent close cooperation and communication of information within the group, which will have a correspondingly negative effect on the efficiency of the individual sub-units.

All 3 organizational forms of research have their respective advantages and disadvantages. Ultimately, the application in practice depends on various criteria and their respective weighting. These decision criteria include the individual quality requirements, the cost situation and various trends and developments in the financial markets.39

2.3.2 Financial research methodology

The core activity of financial analysts is the analysis and evaluation of companies.

As part of the financial analysis, necessary information is collected, processed and evaluated in order to be able to make assessments regarding the future development of the investors' asset positions. The financial analysis enables forecasts regarding future share price developments. On the basis of these forecasts, statements are made about the composition of portfolios (selection) and about recommended transaction times (timing). Appropriate methods are required to be able to make such forecasts.40 It should be noted that the importance of a formalized methodological approach in research has steadily increased in importance in recent years. This is mainly due to the rapid technical development. Quantitative methods in particular have gained in importance in recent years. The increasing complexity of the financial markets also places new and higher demands on the transparency of the methods used due to customers who increasingly question the forecasts made and also want to understand them themselves. The more professional the procedure and the more transparent the methods used, the better the research department of a bank can hold its own against the competition.

Research can be carried out using various methods and can be differentiated according to different criteria. The (1) fundamental analysis and (2) technical analysis represent the two basic types of stock analysis and can be distinguished in the type of input data used.41

(1) Fundamental analysis has established itself as the most important method among financial analysts. Fundamental analysis assumes that the price of a share fluctuates in the long term around the economically correct value of a share, the intrinsic value, and that the prices approach the correct values ​​again over time. The goal of a fundamental approach is to determine the intrinsic value of a share, which is then compared with the current market price, the stock exchange price.42 If analysts determine such deviations, the existing temporary over- or undervaluation of a share can be exploited to achieve investment gains. The intrinsic value of a share is determined by the internal and external company data, which represents the proportional present value of the company's expected future cash flows. The future success parameters of a company include, among other things, profits, cash flows or dividends. These performance indicators are estimated on the basis of detailed analysis of historical and current data and discounted using a risk-adjusted interest rate. Fundamental analysis should therefore be viewed as a future-oriented concept.43 A major advantage of this analysis method is that it is based on a theoretical foundation. However, this procedure is very time-consuming and requires extensive know-how from the analyst company. In addition, the quality of such an analysis is crucially dependent on the quality of the underlying information and data.44

(2) Technical analysis, on the other hand, does not rely on fundamental data; instead, it focuses on analyzing historical stock price developments as well as a range of psychological factors. This analysis is based on the assumption that prices move in trends or in cycles and thus past price developments recur.On the basis of this knowledge, the technical analysts try to filter out certain patterns in the price development by analyzing price charts in order to be able to identify trend progressions and reversal points as early as possible. Based on the information obtained, appropriate forecasts for future price developments are now derived. Important techniques that are used to interpret charts are so-called trend, support and resistance lines as well as trend confirmation and trend reversal information (see Fig. 4 and Fig. 5). In addition, indicators are created that indicate the existence of trend and exaggeration phases. The main advantages of technical analysis are its simplicity and its ability to be carried out quickly. However, this method has the major disadvantage that its approach is not based on any theoretical foundation.45 In addition, further research methods such as quantitative / qualitative and univariate / multivariate can be distinguished. These research methods represent the dimensions for the two basic types, fundamental and technical analysis. As Figure 6 shows, this dimensional differentiation can distinguish a large number of corresponding models.46 In practice, the prognoses are made not only through the stringent application of one method, but mostly by means of a combination of the various models. The vast majority of financial analysts follow the fundamental analytical approach in their analysis practice. The technical analysis is mostly used only as a support or as a supplement. For this reason, the following explanations concentrate on the procedure of fundamental analysis.

2.3.3 The financial research process

The aim of the research is to be able to assess future developments more reliably. The specific research tasks can be derived from this generally formulated goal in a 3-stage research process (see Fig. 7). In the following, the phases of information gathering, information processing and information distribution are to be distinguished. In principle, the individual process steps run one after the other, but they interlock.

2.3.3.1 Obtaining information

The acquisition of information is the first phase of the research process. The immediate acquisition and availability of information is a fundamental requirement for a good analysis of a company. Analysts can access various sources of information as part of their analysis. Sources of information can be differentiated based on their origin. Information that comes directly from the company to be analyzed is one of the primary sources and the other, publicly available information is one of the secondary sources.47

Information that is created on the basis of statutory provisions can be assigned to the first-mentioned category. The legal obligations in Germany include the publication of consolidated financial statements, the obligation to hold an annual general meeting, and the notifications published as part of the ad hoc disclosure requirement in accordance with Section 15 of the WpHG. In addition, additional statutory disclosure requirements apply to listed companies.48 This includes the publication of interim reports. In addition, these companies are subject to the international information and transparency requirements of the respective stock exchanges, for example, requirements for admission to the Prime Standard of the Frankfurt Stock Exchange are regular quarterly reporting, the application of international accounting standards, the publication of a corporate calendar and the holding of at least one analyst conference per year.49 Journalistic publications, general statistics and studies by independent institutes are assigned to the second category. The secondary sources also include the research reports from other sell-side analysts, as well as the forecasts and discussions with this group of analysts. Information from suppliers, buyers and other business partners is also a good way of drawing conclusions about the company to be analyzed.50

Which of these sources of information are used by the analysts depends above all on the benefits that can be achieved through the use. The benefit can be expressed in the form of the information gain, which, however, depends on the analyst's current level of information and on the information costs to be incurred. Further criteria for the choice of a certain information source can be the accumulated experience, the credibility as well as the competence of this source. In addition, the institutional environment, in particular the size of the employer and the availability of resources, represent a criterion. Surveys of analysts found that the information published by the companies themselves is particularly relevant. In addition to the annual and quarterly reports published by the company, direct communication with company representatives is considered very important. In particular, the possibility of personal communication is very important for analysts. One of the reasons for this is that the analysts hope that this personal contact will give them an information advantage over other market participants. In addition, analysts can ask questions that are important to them in personal discussions in order to be able to assess the competence of management.51

In contrast, the information from the secondary sources is only of subordinate importance.52 Nevertheless, the analysts regularly keep themselves busy and informed in the business press and in the various databases of industry, capital and economic statistics. According to analyst surveys, the reports and forecasts of other analysts were assigned the least importance as a possible source of information.53 Nevertheless, it can be assumed that the recommendations and forecasts of other analysts play a not insignificant role in practice (see Section 3.2.3).

2.3.3.2 Information processing

This process stage includes the actual own work of analysts, the preparation of forecasts about the future development of the company. To do this, the acquired data is first analyzed, filtered and processed. In order to create methodologically sound and comprehensible forecasts, the necessary analyzes can be carried out in basically two different directions, the (1) top-down approach and the (2) bottom-up approach.

(1) A top-down analysis is based on the view that companies cannot escape general market developments in the long term. For this reason, the factors that are superordinate to the object to be analyzed are examined first.

An economically oriented analysis of the markets, countries and sectors is carried out in order to filter out the most attractive markets. As part of the macroeconomic analysis, among other things, the economic development, interest rate development, money supply are examined.54 The resulting forecasts for overall economic development are then used to estimate industry developments. This also includes indicators such as the current stock levels and incoming orders, which indicate the development of the industry. From the expected industry development, assumptions about the development of future sales and earnings developments of the company to be analyzed can be made. The forecasts are then formulated on the basis of these assumptions.55

(2) In contrast, the bottom-up approach is based on the microeconomic company level, and the forecasts for the company are formulated accordingly at the beginning. The corresponding estimates for the industry or for the overall market are derived on the basis of these forecasts. The bottom-up approach has the particular advantage that the price-relevant factors of individual stock corporations can be determined more effectively. However, this methodology is much more time and resource intensive than a top-down approach. In addition, there is a risk that important macroeconomic issues are neglected, which can certainly have a greater impact on corporate development. Therefore, in practice, both methods are usually used in parallel in order to better check the plausibility of the results. The company value is determined on the basis of the forecast key figures. The valuation methods most frequently used in practice include the multiplier method and the DCF method.56 The result of the financial research process is the research report. Profit forecasts represent a particularly popular set of instruments, which are very central input factors for the research report. Research reports are usually published once or twice a year and adjusted during the year if necessary. Based on the difference between the calculated company value and the share price or the market value of the company, the investment judgment is made. The resulting difference describes the expectation of the company's future share price development and ultimately results in the recommendation for the share. It is undervalued if the calculated fair value is above the current price level of the share. This stock would be rated as a buy recommendation by analysts. Respectively, a fair value, which is below the company value, is a share that is rated as a sale. Depending on the respective analyst company, the recommendation is made in different recommendation categories. The three main valuation categories are “Buy”, “Hold” and “Sell”. Multi-level rating systems are often used in order to be able to differentiate more particularly the positive area (cf. Tab. 1). This gives the analysts additional flexibility and enables them, in particular, to formulate negative assessments more indirectly and more positively. For example, five-level rating systems subdivide the buy and sell recommendations again into strong buy and (moderate) buy and into (moderate) sell and strong sell. The problem that arises from the various differentiations of the recommendations is that there is no longer any clear recommendation for action for investors. In addition, this leads to confusion among investors, as a hold recommendation can often be rated as a sell recommendation. It is also problematic that some analyst firms base their recommendations on the share price target and others on the development of the share price.575859 In summary, information processing represents the value-creating process stage of financial analysts by filtering the unstructured information from various sources and transforming it into an assessment or forecast.

2.3.3.3 Information Distribution

The analysts' assessment of the company's opportunities and risks and the overall results of the analysis are then published as research reports. These studies vary in terms of their complexity and level of detail, depending on the customer group. The research reports for institutional investors have to meet much higher requirements than the studies for private investors or small investors. This is justified by the fact that institutional investors usually have extensive economic and statistical-analytical expertise and research reports are only useful for this group if they go beyond conveying this knowledge and actually present new information. The main target group for the analyst studies are institutional investors anyway, if only because of their much higher investment volumes.60 The research reports are disseminated in two consecutive ways. First, the studies are made available to the analysts' own customers (primary information processing). The aim is to market the relevant investment recommendations and convince customers to invest in the relevant securities. After the information has been provided to one's own customer base, the studies are made available to the general public (secondary information processing). These include information and news services such as Reuters or Bloomberg, as well as commercial data providers on the Internet and stock market letters.61 This delay in the transmission of research to the public is due to the fact that analysts initially want to enable their own customers to act early. Accordingly, it can be assumed that the course reactions to the recommendations and prognoses will for the most part occur at the time of primary information processing and will be priced in accordingly when the public finds out.

3 factors influencing the quality of financial research

The area of ​​equity research is very important for banks and brokerage houses due to the enormous demands on resources. The analyst assessments are also of great interest to investors and companies, as they represent the basis for their investment decisions and they reduce the problems and costs (agency costs) that arise from the different levels of information between company management and investors. This, in turn, can result in lower capital costs and higher share prices for companies. However, these positive effects will only materialize if the forecasts and recommendations are of a correspondingly high quality. The quality of the forecasts and recommendations are influenced and determined by a wide variety of factors. The basic prerequisite for achieving the highest possible quality of financial research is that the financial analysts act objectively and independently when preparing the forecasts and recommendations. Analysts can basically distinguish between two aspects of independence. The term independence describes the lack of influence from third parties, as well as the degree of influence of analysts' own interests on the opinion-forming process. Analysts also have to carry out their activities objectively and with integrity. Integrity generally includes incorruptibility, honesty, completeness and integrity.62 Accordingly, the analysts should perform their tasks with due diligence and honesty in the interests of their clients. Objectivity exists when the judgment is made factually, impartially and impartially.63 The dependency or independence of an analyst are decisive influencing factors in the preparation of research. Ultimately, the result can be described as either objective or non-objective research.

In the subsequent investigation, therefore, the factors are identified and described which can influence the quality of the financial research. The central question is, are the forecasts and recommendations of the analysts objective and independent despite the existence of various influencing factors? Section 3.1 first presents the empirical findings on the market impact and the general quality of profit forecasts and stock recommendations. The influence of behavioral determinants in the preparation of forecasts and recommendations is presented in Section 3.2. In particular, the influence and effect of behavioral anomalies and heuristics in the information and decision-making process should be discussed. Which conflicts of interest the analysts are exposed to and which self-interests can influence the objectivity and independence of the research results are discussed in section 3.3. Section 3.4 identifies further, specific determinants for the quality of financial research. In addition, in the last section 3.5, the legal and professional regulations are discussed in more detail.

3.1 Empirical findings on the recommendations and forecasts

3.1.1 Price reactions upon publication

The assessments of analysts are very important on the capital market. Institutional investors in particular often make portfolio adjustments immediately after the publication of analyst studies. The forecasts and recommendations therefore presumably have a considerable potential to influence the market and can lead to significant price reactions.

[...]



1 Bangert (2008), p. 10.

2 See Göres (2004), p. 1 ff.

3 See Friedrich (2007), p. 39; Hax (1998), 11 ff.

4 DVFA (2000a), p.48.

5 See Döring (2000), p.121; Von Rosen / Gerke (2001), p. 11 f.

6 See Von Rosen / Gerke (2001) p.11 f.

7 See Wichels (2002), p.31 ff.

8 See Mikhail / Walther / Willis (2004), p. 68; Von Rosen / Gerke (2001), p.1.

9 See Schnell, C. (2005), p. 27.

10 See Göres (2004), p. 32; Pietzsch (2004), p. 11 f.

11 See Aulibauer / Thießen (2002a), p. 5.

12 See Von Rosen / Gerke (2001), p. 10 f.

13 See Friedrich (2007), p. 44 f.

14 Hax (1998), p. 46.

15 See Stanzel (2007), p. 11 ff.

16 See Gerke (2002), p. 444.

17 See von Rosen / Gerke (2001), p. 10 f .; Pietzsch (2004), p. 18 f.

18 Fama (1970), p. 383.

19 See Fama (1970), p. 383.

20 See Stanzel (2007), p. 26.

21 See Henze (2004), p. 8.

22 See Pietzsch (2004), p. 23 f .; Seeger (1998), p. 33 ff.

23 See Sapusek (1998), p. 115 ff .; Seeger (1998), p. 30 f.

24 See Paul (1999), p. 650 ff .; Aulibauer / Thießen (2002b), p. 50 f.

25 See Henze (2004), p. 6 ff .; Michaelsen (2001), p. 70 ff.

26 See Bessler / Stanzel (2006), p. 228 ff.

27 See Stanzel (2007), p. 30 ff.

28 See Stanzel (2007), p. 33.

29 See Pietzsch (2004), p. 29.

30 See Friedrich (2007), p.57 ff.

31 See Henze (2004), p. 10 ff.

32 See Paul (1999), p. 656 ff .; Perridon / Steiner (2003), p. 50.

33 See Nassauer (2000), p. 27 ff.

34 See Schmidt / Weiß (2003), p. 12.

35 See Gerke (2002), p. 676.

36 See Pietzsch (2004), p. 13.

37 See Diehl (1998), p. 7 f.

38 See Zimelka (2002a), p. 641.

39 See Zimelka (2002a), p. 637.

40 See Klein (1999), p. 49; Zimelka (2002b), p. 660.

41 See Steiner / Bruns (2002), p. 227 ff.

42 See Perridon / Steiner (2003), p. 218.

43 See Pietzsch (2004), p. 12.

44 See Michalkiewicz (2003), p. 126; Dette (1998), p. 35 ff.

45 See Poddig (1996), p. 51 f .; Dette (1998), p. 41 ff.

46 See Zimelka (2002b), p. 659.

47 See Michaelsen (2001), page 41 ff.

48 See Friedrich (2007), p. 44 f.

49 See Deutsche Börse (2009).

50 See Henze (2004), 15 f.

51 See Friedrich (2007), p. 71 f.

52 See Hax (1998), p. 12 ff.

53 See Zimelka (2002b), p. 660 f.

54 See Steiner / Bruns (2002), p. 230.

55 See Friedrich (2007), p. 75.

56 See Wichels (2002), p. 66; Friedrich (2007), p. 76 f.

57 See Pietzsch (2004), p. 67 ff .; Henze (2004), p. 17 f.

58 See Göres (2003), p. 66 f.

59 See Schumacher / Kagelmann (2001), p. 62 f.

60 See Michalkiewicz (2003), p. 127 f .; Göres (2004), p. 61.

61 See Hax (1998), p. 21; Pietzsch (2004), p. 70 f.

62 See Brockhaus (1989), p. 555.

63 See DVFA (2006), p. 1.

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