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The Distorting Incentives of Relative Performance Evaluation for Equity Analysts ∗

We study the strategic behavior of equity analysts whose compensation is based on relative performance of their stock recommendations. Our model predicts that riskaverse analysts issue identical recommendations to avoid falling behind their peers. Top analyst awards, on the other hand, motivate analysts to issue bold recommendations. However, when the stock return is very volatile, the herding incentive dominates. As a result, dispersion of recommendations away from the consensus is only likely for lowvolatility stocks. Consistent with the predictions, our empirical analysis finds a negative relationship between the dispersion of recommendations and stock return volatility.