Analysts, Incentives, and Exaggeration

Sell-side analysts are compensated, at least in part, by brokerage commissions. These commissions create an incentive to bias forecasts to generate trade. Thus, analysts have clear economic incentives to deceive and traders have economic incentives to detect deception. Prior analytical theories of information transmission games starkly predict that there will always be some deception (with trade) at best and uninformative messages (and no trade) at worst when the sender's and receiver's incentives are not aligned. Prior experimental evidence of information transmission games show senders do elect to deceive, although they send messages more informative than theory predicts. Likewise, receivers rely more upon messages than theory predicts. Can behavior that deviates from prediction be explained by normative social behavior, such as trust and honesty? Alternatively, are subjects boundedly rational, failing to sufficiently consider other players' incentives when predicting their decisions? To answer these questions, I design and conduct an experiment to investigate whether forecasting and trading behaviors are best explained by analytical theory, limited strategic sophistication, or social norms. The experimental results confirm a majority of subjects adopt dishonest forecasting strategies, but at the same time, a majority of subjects adopts trusting trading strategies. Additionally, subjects do not appear to revise trading behavior despite evidence of deceptive forecasts. The results suggest subjects' behavior within the setting is better explained by limited strategic sophistication than by social normative behavior or sequential rationality.
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