Share pledging and bias in analyst earnings forecasts : evidence from a natural experiment

Abstract

This paper studies whether financial analysts strategically issue biased forecasts when the corporate insiders pledge shares for personal loans. Using the share pledging data in China from 2009 to 2017, I find that analysts distort their earnings forecasts to help the insiders alleviate the margin call pressure. Specifically, analysts are more likely to be positively biased when controlling shareholders pledge their shares for loans. Utilizing a regulatory change that exogenously reshapes the share pledging practice in 2013 that permits the brokerage firm to be the pledgee in the Chinese market, I find that analysts’ forecasts are more upward biased when the pledgee is a brokerage firm instead of a bank or a trust firm. Using the regulatory reform, I’m allowed to identify a new type of affiliation between an insider from a listed firm and an analyst from a brokerage firm when a pledging contract is signed. The results show that the affiliated analysts issue more positively biased forecasts after their brokerage firm becomes the pledgee, suggesting that analysts strategically provide upward biased forecasts to help controlling shareholders avoid margin calls when the relationship is developed. In addition, I find that the affiliated analysts issue more accurate forecasts in the following years, indicating that they are rewarded by the insiders and have better access to corporate information. My study highlights the relationship between a financial analyst and a pledging insider and has implications for the effects of share pledging.