Tipping

This paper investigates the trading behavior of institutional investors immediately prior to the release of analysts’ initial buy and strong buy recommendations. Using a proprietary database of institutional trading activity from the Plexus Group, we document abnormally high trading volume and abnormally large buying imbalances beginning five days before initial recommendations are publicly released. Furthermore, the magnitude of the trading imbalances are related to variables that are typically associated with positive price responses to initiations, including strong buy recommendations, the analyst being an all-star analyst, and lower prior dispersion in analysts forecasts. We confirm that institutions buying prior to the recommendation release earn positive abnormal trading profits. Taken together, our results suggest that some institutional traders receive tips regarding the contents of forthcoming analysts’ reports. To the extent that brokerage firm clients who benefit from these tips are more likely to direct business to the initiating brokerage firm, tipping provides economic profits to the brokerage that can help defray the cost of analyst information gathering. Thus, while tipping benefits some traders at the expense of others, the welfare consequences of tipping are unclear.