Many market participants believe that sell-side analysts are too optimistic in their recommendations to buy stocks, and too slow to recommend sells. What factors might explain this bias?

Answer 1

Need for access to firms. Sell-side analysts often depend on information from the firm to answer questions about firm performance and strategy not contained in other public information about the firm. This information can make an analyst's reports more thorough and persuasive to potential investors. Furthermore, higher quality reports can increase revenues for the firm and compensation for the analyst. After a sell recommendation, firms are less likely to be as open and forthcoming with analysts who have recommended a sale. Conversely, a strong recommendation to buy a firm's stock may result in greater access to the firm in the future. Hence, the sell-side analyst could provide optimistic recommendations to help guarantee access to the firms they cover.
Potential for investment banking services by the analyst's firm. Investment banking services can be a significant source of income for brokerage/investment banking firms. Moreover, firms are more likely to use the investment banking services of brokerage/investment banking firms that issue favorable recommendations. A negative recommendation may cause the brokerage/investment banking firm the loss of significant additional revenues from underwriting or investment banking services in the future. As a result, sell-side analysts may be more likely to be optimistic in recommendations about a specific firm.
Difficulty of taking advantage of a sell recommendation. It may be more difficult for a brokerage firm's client to take advantage of a sell recommendation. A much narrower group of clients can take advantage of a sell recommendation. If a client owns the stock, he can sell it outright. If the client does not own the stock, he must find another stockholder to borrow it from in order to short it and take advantage of the recommendation. Furthermore, short sales are typically more expensive than regular stock purchases, last only a finite amount of time before expiring, and carry a higher risk for the investor. Hence, a sell recommendation for a stock is less likely to generate the same revenues for the firm as a buy recommendation.