Getting Out Early: An Analysis of Market Making Activity at the Recommending Analyst's Firm

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Abstract
We explore how analyst recommendation changes affect a security's trading volume at the market maker of the analyst's own firm. Using Nasdaq PostData, we find a dramatic increase in trading volume handled by the market maker of the analyst's firm relative to other market makers on recommendation release days. On days when upgrades are released, buying volume increases appreciably at the recommending market maker's firm. For downgrades, however, we find no disproportional sell volume on the day of the recommendation release. Instead, we find evidence of increased selling at the downgrading analyst's firm in the two days prior to the official release of a downgrade. This pattern of activity constitutes new evidence on compensation for research production through the market-making channel. The latter evidence is consistent with clients being rebated part of these research expenses through limited pre-release, in effect, a new form of "soft dollar" benefit. Particularly in light of recent regulatory changes, these findings also raise questions about the selective release of negative news.