Client Relationships, Analyst Coverage, and Earnings Management

SYNOPSIS Financial analysts have two important roles in the capital market. In addition to their informational role, which has been widely studied, they play an important monitoring role. Similar to their informational role, their monitoring role might be negatively affected when they face conflicts of interest. Using a sample of Chinese firms, we show that if analysts are under pressure (i.e., housed in a brokerage firm where specific mutual funds hold large positions in a company covered by the analyst), their role in lowering the firm earnings management activities is significantly compromised. We find that the closer the business relationship between the mutual fund and the brokerage firm, the greater the firm earnings management. Our findings caution investors and regulators to heed the impact of client pressure on analysts' roles in financial markets.