Buys, Holds, and Sells: The Distribution of Investment Banks' Stock Ratings and the Implications for the Profitability of Analysts' Recommendations

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Abstract
This paper analyzes the distribution of stock ratings at investment banks and brokerage firms and examines whether these distributions can be used to predict the profitability of analysts' recommendations. Consistent with prior work, we find that the percentage of buy recommendations increased substantially from 1996-2000. Starting in mid-2000, however, the percentage of buys decreased steadily. Our analysis strongly suggests that this is due, at least in part, to the implementation of NASD Rule 2711, which requires brokers' ratings distributions to be made public. Notably, over our sample period the difference between the percentage of buy recommendations of the large investment banks singled out for sanction in the Global Research Analyst Settlement and that of the non-sanctioned brokers is economically quite small. Additionally, we find that a broker's stock ratings distribution can predict the profitability of its recommendations. Upgrades to buy issued by brokers with the smallest percentage of buy recommendations significantly outperformed those of brokers with the greatest percentage of buys, by an average of 50 basis points per month. Further, downgrades to hold or sell coming from brokers issuing the most buy recommendations significantly outperformed those of brokers issuing the fewest, by an average of 46 basis points per month.