UC Berkeley

This dissertation studies the effects of compensation incentives on individual behavior. Specifically, I look at changes in effort and risk-taking behavior among financial analysts, investment managers, and teenagers. The main chapter focuses on sell-side analysts. Evidence shows that investors heed to the predictions of sell-side analysts, who influence stock market prices. The informational content of their predictions depends on their incentives to reveal unbiased information. I hypothesize that relative performance evaluations provide analysts with incentives to distort their private information. The incentive cycle of analysts starts and ends mid-year, while their predictions are validated in the middle of this cycle. Hence, analysts with good early performance benefit later from sticking to the consensus (herding), while analysts with poor early performance can only escape their low standing by taking risk and deviating from the consensus (anti-herding). I confirm the hypotheses using data from 1990 through 2010 that include analyst recommendations and stock performance. The results suggest that asset price variation that is not due to fundamental are better understood in the context of the incentives that drive analyst behavior.