Optimism Biases among Brokerage and Non-Brokerage Firms' Equity Recommendations: Agency Costs in the Investment Industry

This paper studies the investment recommendations made by brokerage and nonbrokerage firms in an effort to examine the differential agency costs across three unique recommendation production environments. Using the ACE database, recommendation production environments are categorized into national, regional, and non-brokerage firms. The results prove that differences exist between brokerage and nonbrokerage firms: 1) brokerage firms significantly inflate recommendations; 2) regional firms significantly inflate recommendations, compared to national firms; 3) brokerage firms' recommendations, compared to nonbrokerage firms' recommendations, are less credible and less predictive of future stock performance; 4) national firms have more reputational capital, and therefore, their recommendations are more predictive of investment performance than the regional brokerage firms' recommendations.