The effect of institutional investor distraction on analyst forecasts

Abstract

I examine financial analysts' forecasts for firms whose incumbent institutional investors (IIIs) are temporarily distracted. I find that financial analysts react to an increase in institutional investors' distraction by providing more- thorough forecasts. This effect is mainly driven by the distraction of two types of institutions: quasi-indexers and banks. Consistent with stronger investor demand for analyst-provided information when a firm's overall reporting quality is lower and when concern about managerial misbehavior is higher, I find that the effect was stronger before the passage of the Sarbanes-Oxley Act in 2002 and for firms with inferior corporate governance. The effect is also stronger for analysts affiliated with smaller brokerage firms. I also find that analysts issue fewer optimistic forecasts and less-optimistic recommendations for firms with distracted institutional investors. Overall, my findings imply that financial analysts cater to an increase in institutional investors information demand by allocating more efforts to firms when the firms' institutional investors are temporally distracted.