Ethical Review of Social Sciences

Durham & Thunmann, 2025. Published under a Creative Commons Attribution 4.0 International (CC BY 4.0) license.

https://doi.org/10.70150/wnyczh29

INCENTIVES FOR ACCURACY IN ANALYST RESEARCH

PATRICIA CRIFO*

HIND SAMI**

Abstract:

This paper develops a model to explore the dynamic interaction

between incentive contracts and financial analysts' efforts in

producing high-quality research, while accounting for both ethical

and reputational concerns. Our findings indicate that

compensation structures shaped by reputational and ethical

considerations can give rise to incentive-related challenges.

Specifically, an exclusive reliance on financial incentives

exacerbates conflicts of interest, as analysts may prioritize short-

term gains at the expense of their long-term reputation. In contrast,

a more balanced approach, which integrates both monetary and

non-monetary rewards aligned with analysts' intrinsic work ethic,

allows them to better resist such pressures, leading to enhanced

research quality and a strengthened long-term reputation.

Keywords: Motivation, Reputation, Reporting, Investment

Analysts.

JEL Classification: M14; M12; M52; K31; C23

Introduction

Financial analysts play a critical role in shaping

financial markets by offering insights that guide

investment decisions and influence market dynamics.

However, conflicts of interest, arising from

compensation structures, reputational concerns, and

ethical dilemmas, can impact the accuracy and

transparency of their reporting. These conflicts can

either enhance or undermine market efficiency,

depending on the nature of the incentives at play.

Notable scandals, such as the 2020 Wirecard fraud,

underscore the risks associated with misaligned

incentives. In this case, despite clear red flags,

external auditors, internal controls, and regulatory

bodies failed to take timely action, and analysts faced

pressure to present a favourable outlook, which

compromised the accuracy of their assessments. This

incident highlights the need for enhanced oversight

mechanisms that encourage truthful and accurate

reporting, even though such forecast and reports may

negatively affect a company's stock performance.

Similarly, the 2016 Wells Fargo scandal, triggered by

the incentive structure for cross-selling, involved the

creation of millions of unauthorized accounts to meet

aggressive sales targets. Senior analysts, in turn,

overlooked the associated risks. In light of recent

incidents that illustrate how pressure-driven, short-

term incentives can distort analysts' reporting

behaviors, this paper emphasizes the need for stronger

regulatory oversight to ensure that analysts provide

accurate and truthful information, even when such

reports may negatively affect a company's stock

performance.

To tackle this important issue, we explore the

influence of incentive compensation contracts on

security analysts' reporting behavior. To do so, we

propose a theoretical model that assesses the effects of

such contracts on analysts' reporting practices,

accounting for both analysts’ reputational and ethical

concerns. The incentive structures governing analysts’

behavior are crucial in determining the quality and

integrity of financial reporting. In particular, we focus

on the trade-off between short-term financial

incentives and long-term reputational concerns, where

incentives may include both financial and non-

financial rewards. Previous studies have highlighted

how conflicts of interest, such as analysts issuing

overly optimistic reports to secure lucrative

underwriting deals, can undermine their credibility

with investors and lead to long-term reputational

damage (Dechow et al., 2010). Within this framework,

* École polytechnique, CREST and E4C (France) and

CIRANO (Canada)

patricia.crifo@polytechnique.edu

** University of Lyon and Coactis (EA 4161)

hind.sami@univ-lyon2.fr

Acknowledgement

We thank participants at the European Accounting Association Conference, the

MACORGESCP EAP seminar, and the École Polytechnique Seminar. This work

has been carried out at the Energy4climate (E4C) interdisciplinary center of

IPParis, which is in part supported by 3d programme d’investissement d’avenir

(ANR-18-EUR-0006-02). Support from IdR FDIR 2016-2025 (Ecole

Polytechnique and TSE IDEI) is gratefully acknowledged. Of course, the usual

disclaimer applies.

analysts may prioritize short-term financial rewards

over their long-term reputation for providing accurate

and objective information (Hong & Kubik, 2003).

The design of compensation contracts for financial

analysts requires careful consideration of the inherent

conflicts of interest that arise in their research

activities, particularly in balancing long-term

reputational concerns with short-term incentives.

Agency theory highlights the potential hidden costs of

relying exclusively on monetary incentives, especially

in cases where analysts are intrinsically motivated

(Benabou & Tirole, 2003; Lindenberg, 2001; Deci &

Ryan, 1985; Frey & Oberholzer-Gee, 1997; Kreps,

1997). This paper extends this framework by arguing

that compensation structures for analysts should

incorporate both financial and non-financial

incentives, with particular attention to work ethic and

professional integrity (Noe & Rebello, 1994; Carlin &

Gervais, 2009). Since ethical considerations and

intrinsic motivations are private and difficult to

observe, firms must design contracts that not only

address analysts’ financial incentives but also screen

for their ethical preferences. Drawing on the work of

Heinle, Hoffman, and Kunz (2012), we propose that

analysts may experience ethical distress when their

forecasts and reporting activity deviate from the

standards and ethical norms outlined in their

compensation contracts. This distress can lead to

compromised research quality and undermine the

accuracy of their investment recommendations.

Therefore, to ensure that analysts provide objective

and truthful assessments, compensation contracts

must be structured to align both financial rewards and

ethical incentives, mitigating the pressure to prioritize

short-term gains over long-term credibility. We thus

argue that it is essential for compensation contracts to

account for these ethical dimensions in order to ensure

that analysts are incentivized to maintain the integrity

of their research, even in the face of short-term

financial pressures.

The role of financial analysts encompasses a range

of tasks, including data collection, company visits,

forecasting, and the production of research reports that

inform investment recommendations. We model this

process as one in which an analyst’s research effort

involves interpreting data, drafting reports, and

formulating investment recommendations. The firm

subsequently offers a contract that ties compensation

to the quality of the research produced, which is

assessed based on the accuracy of forecasts and the

value of stock reports to investors. The value of these

reports is determined by the information it provides.

Our model incorporates the understanding that an

analyst’s research effort is influenced by both

monetary incentives (performance-based) and non-

monetary incentives (such as ethical distress). When

an analyst is intrinsically committed to delivering

high-quality research, financial incentives may be

unnecessary. However, when this commitment is

lacking, the firm may need to introduce performance-

based compensation linked to both the

informativeness and accuracy of the research

produced. We propose that conflicts of interest emerge

when substantial monetary incentives undermine

research quality, as significant financial rewards

increase the temptation to compromise on

thoroughness and objectivity. Our dynamic analysis

explores the trade-off between monetary and ethical

incentives in shaping compensation contracts that

seek to balance short-term financial rewards with

long-term concerns about an analyst’s reputation and

the integrity of their research.

Our analysis reveals that the structure of

compensation contracts can significantly influence

incentive dynamics, particularly in the context of

reputational concerns and work ethic. Specifically,

contracts based entirely on financial incentives - full

financial incentives contracts - tend to amplify

conflicts of interest, encouraging analysts to prioritize

short-term gains at the expense of long-term

reputational capital. In contrast, leveraging an

analyst's intrinsic work ethic fosters higher-quality

research, thereby enhancing long-term reputation.

Overall, while purely financial incentive contracts

appear detrimental to both research quality and long-

term reputational outcomes, hybrid incentive

structures - mixed incentives contracts- can mitigate

these conflicts, facilitating an equilibrium where high

research quality and robust reputation coexist.

We contribute to two key strands of literature. First,

we examine how compensation contracts impact

analyst bias in reporting. Incentive structures often

reward short-term performance through bonuses tied

to trading volume, investment banking deals, or client

relationships, which can conflict with objective

reporting (Kothari, Ramanna, & Skinner, 2010).

Much research has focused on the role of financial

analysts as information providers (see Womack, 1996;

Barber et al., 2001; Jegadeesh et al., 2004) and how

their expertise and firm relationships affect

performance (Madureira & Underwood, 2008;

Ljungqvist et al., 2006). Benabou and Laroque (1992)

explore analysts' incentives to profit from superior

information, while Morgan and Stocken (2003) show

how investment banking conflicts can bias

recommendations and reduce report informativeness.

Similarly, Ergungor et al. (2007) find that lending-

affiliated analysts offer more accurate earnings

forecasts to protect their reputation but may provide

overly optimistic recommendations to benefit their

lending clients. Guo, Li, and Wei (2020) stress that

analysts often issue overly optimistic forecasts for

profitable firms or potential investment banking

clients, indicating a persistent bias from incentive-

driven conflicts of interest. Lastly, Zhang et al. (2022)

show that analysts with compensation tied to trading

commissions tend to issue more frequent, favourable

updates, particularly for firms with existing business

relationships, demonstrating how compensation

incentives can influence report positivity and

immediacy, often at the cost of objectivity. We

contribute to this literature by exploring how

performance-based compensation affects analysts’

research and reporting. We show that contracts

rewarding analysts solely based on financial accuracy

can unintentionally lower research quality. Analysts in

such arrangements often prioritize short-term gains

over long-term credibility, leading to a decline in

rigorous analysis. In contrast, a balanced incentive

structure—combining both financial and ethical

rewards—tends to support higher-quality research, as

it encourages analysts to focus on integrity and

reliability. Overall, purely financial incentives may

harm long-term quality and reputation, while mixed

incentives can align analysts' motivations with both

research quality and reputation goals, fostering a

stable, high-quality research environment.

The second strand of literature explores how

reputation, ethics, and career concerns influence

analyst forecasting. Milbourn et al. (2001) show that

long-term career concerns can motivate analysts to

produce accurate information, while Bolton et al.

(2007) highlight how conflicts of interest may hinder

full disclosure. Chen and Marquez (2009) further

explore how career concerns and short-term

compensation shape analysts' incentives. Reputation

is a key factor in driving analysts to maintain accuracy

and integrity (Chen et al., 2023; Lu et al., 2018). High-

reputation analysts often gain career benefits, such as

promotions and market credibility, incentivizing

unbiased reporting. However, reputation alone may

not counteract incentives for optimistic forecasts,

especially during market uncertainty (Chang & Choi,

2017). The ethical dimension of analyst behavior has

gained attention, with research showing that analysts

in firms with strong ethical or ESG standards tend to

provide more accurate forecasts (Schiemann &

Tietmeyer, 2022; Cowan & Salotti, 2020). This

suggests that public or private regulatory pressures,

combined with incentive structures favoring long-

term performance, can help deter biased reporting.

Our approach complements this literature as we

analyze how compensation structures may provide

adequate incentives to analysts to avoid exploiting

conflicts of interest. In particular, we endogenously

derive the incentive structure of the analyst by

modelling the interaction between the investment

bank and the analyst, when both reputational and

ethical concerns matter. We show that implicit

incentives arising from the presence of ethical

concerns play a crucial role in inducing analysts to

resist pressure from conflicts of interest. Our theory

indicates that without ethical considerations at stake,

the attraction of lucrative compensation and then the

temptation to liquidate reputation for profits are

stronger for reputable analysts.

The remainder of the paper is organized as follows.

Section 2 presents the model. Section 3 presents the

equilibrium behaviors of agents. Section 4 analyzes

the stationary equilibrium and discusses the main

results of the paper. Section 5 concludes.

1. Model

1.1. Timing

The model has three dates, t, t + 1 and t + 2. All

agents are risk neutral. The economy is composed of

a continuum of financial analysts and a continuum of

investment banks. At date t, analysts are employed by

investment banks to conduct research on the clients’

firms ongoing operations and provide forecast or

recommendations about the firms’ earnings. We

model the relationship between the employer and the

analyst as a principal-agent relationship with moral

hazard due to imperfect observability of the analyst’s

research effort.

Traditional proxies for research activity typically

encompass metrics such as the frequency of forecast

revisions, the number of coverage initiations, and the

volume of research notes disseminated. These outputs

represent the analyst's efforts to generate information,

albeit yielding a noisy signal regarding the firm's

earnings prospects. The analyst uses this information

to provide forecasts to his investor client at date t + 1.

The employer must design a contract that

effectively addresses the moral hazard problem

inherent in the analyst’s role. Analyst compensation

structures are inherently complex, incorporating

diverse mechanisms for incentivization. Within the

framework of this model, we assume that all contracts

include financial incentives to encourage analysts to

deliver valuable insights to investor clients. However,

we differentiate between two distinct categories of

contracts. The first category incorporates additional

financial rewards for the provision of qualitative

insights, such as Environmental, Social, and

Governance (ESG) information, thereby aligning

incentives with the delivery of such data. In contrast,

the second category excludes explicit financial

incentives for such qualitative insights, relying instead

on the analyst's intrinsic ethical commitment to

underscore the importance of this information.

The timing of the model is summarized as follows.

 date t:

Financial analysts and employers are matched one-

to-one randomly. The analyst uses her unit time

endowment to exert a research effort, θt

 date t + 1:

The employer offers a contract to the analyst,

The analyst accepts or rejects the contract

The analyst’s effort level in acquiring information

determines the value of her forecast which is

imperfectly observable by the employer, and contains

both quantitative (et+1) and qualitative (qt+1,)

information

 date t + 2:

Realized value of the client firm is revealed to all

participants, and the analyst receives payoff according

to the value (i.e. public and private information) of the

forecast

1.2. Output and profits

The contractual relationship is modeled based on

the linear multi-task approach developed by Itoh

(1994) and Feltham & Xie (1994), from Holmstrom &

Milgrom (1987, 1991)’s canonical model.

In this framework, observable output is defined

over quantitative and qualitative information

contained in the analyst’s forecast by

y t+1 = e t+1 + q t+1 + ε t+1 (1)

where:

e t+1 is the effort for gathering quantitative

information,

q t+1 is the effort for gathering qualitative

information

ε t+1 is a random (noise) term with distribution

Ν(0,(σ t+1 )²)

The analyst’s expected compensation is

E(w t+1 ) = α . Ε( y t+1 ) + β (2)

where α and β are endogenous parameters

determined so as to maximize the employer’s

expected profits (see appendix)

The analyst’s net compensation is

ω t+1 = E(w t+1) - C(e t+1, q t+1) (3)

where C (.,.) is the analyst’s cost of efforts defined

below (equations 8a and 8b)

The employer’s expected profit is defined by

B t+1 = π(ρ t+1) . Ε( y t+1) - E(w t+1 ) (4)

where

π(ρ t+1) is the employer reputation level

ρ t+1 is the analyst’s productivity

Ε( y t+1) is the firm’s expected profit

E(w t+1) is the analyst’s expected compensation

Firm reputation is defined as in Kreps (1990):

π(ρ t+1)= ρ t+1 / [ρ t+1 + (1−ρ t+1) η t+1] (5)

where η measures the weight of unproductive

behaviors or external judgments.

This functional form captures the idea that a firm's

reputation depends on the interaction between an

employee's productivity (ρ t+1) and an external factor

or parameter (η), which determines the relative

influence of unproductive actions or their external

perceptions.

1.3. Analysts’ Utility and Productivity

The analyst’s utility depends both on leisure time

and consumption.

During the first period (from t to t+1), the analyst

allocates her unit time endowment to undertake

research efforts, represented by θt. The research effort

cost corresponds to the time invested in research

activity.

In the second period (from t+1 to t+2), the analyst's

consumption level is represented by ct+1. The analyst

earns a wage and consumes only during the second

period. Consequently, the budget constraint is given

by c t+1   t+1, where  t+1 is the expected wage (net

of effort costs) defined previously.

Since the analyst consumes all earnings in the

second period (with no savings or bequests),

substituting c t+1 into the intertemporal utility function

yields the following expression for the analyst’s

utility:

ut+1 = log(1 − θt) + log ωt+1 (6)

with 1 − θt the first period leisure time and ωt+1 the

net compensation received in the second period.

The analyst’s productivity in t + 1, ρt+1 depends on

two arguments: the research effort, θt, and the

productivity level, ρt:

ρt+1 = ρ (ρt,θt) (7)

where ρ (.,.) is increasing in both arguments,

differentiable and concave.

More specifically, when computing the

equilibrium, we will assume that:

ρt+1 = At (θt)γ (ρt) 1-γ (7’)

where 0 < At ≤ 1is an efficiency parameter and 0 <

γ<1.

1.4. Incentives and effort for quantitative and

qualitative information

In the second period (between t+1 and t+2), the

employer offers the analyst a contract that includes

financial rewards for effort on quantitative (hard)

information, e t+1, and may also incorporate additional

incentives for qualitative (soft) information, q t+1. As a

result, two types of contracts arise:

 A Qualitative Information Incentive Contract:

This contract offers financial incentives for

providing quantitative information, and offers

additional financial incentives for qualitative

insights (e.g. including ESG-related

information).

 An Ethics-Driven Contract: This contract offers

financial incentives for providing quantitative

information, but does not provide financial

rewards for qualitative insights like ESG

information, relying instead on the analyst's

ethical commitment.

The objective of the employer is to design the

contract in a way acceptable by the analyst (i.e. such

that participation is ensured) and inducing the analyst

to exert the maximal effort level (i.e. such that it is

incentive compatible).

In period 2 (t+1 to t+2), the effort cost function

depends on the type of contract that the analyst has

accepted.

With a Qualitative Information Incentive Contract,

additional financial incentives for providing

qualitative insights are provided

, the effort cost is

then defined by:

C(e t+1, q t+1) = (et+1)2 / 2 + (qt+1)² / 2 + µ  (q t+1 

e t+1) (8a)

where -1<µ<1 is the degree of interdependence

between effort for gathering quantitative and

qualitative information.

With an Ethics-Driven Contract, qualitative

insights are not incentivized, relying instead on the

analyst's ethical commitment, the effort cost is then

defined by

C(e t+1, q t+1) = (et+1)2 / 2 + λ  (q t+1 - e t+1)2 / 2

(8b)

The parameter λ, where 0< λ <1, quantifies the

degree to which the analyst internalizes or identifies

with the acquired qualitative information. Thus, λ

serves as a measure of the ethical tension or "ethical

distress" experienced by the analyst when engaging

with qualitative information. This construct can be

interpreted as a reflection of the analyst's adherence to

normative principles or their intrinsic work ethic.

A similar assumption is made in Itoh (1994).

2. Equilibrium

2.1. Second period equilibrium

To compute the model’s equilibrium, we start

backward with the second period equilibrium.

Comparing the firm’s expected profits under the two

possible contracts we get the following result.

Assumption 1:

0< ρt+1 <1 , that is: 





 

Proposition 1.

Under Assumption 1, the equilibrium contract that

maximizes the firm’s expected profits Bt+1 is the

Ethics-Driven Contract if and only if the analyst’s

productivity is below the following threshold level

 

󰇛󰇜 where 





and  

 ;

if the analyst’s productivity is above the threshold

level, the equilibrium contract that maximizes the

firm’s expected profits Bt+1 is the Qualitative

Information Incentive Contract.

Proof: see appendix 5.1.

Under the Ethics-Driven Contract, financial

incentives are exclusively allocated to the provision of

quantitative information, whereas the Qualitative

Information Incentive Contract extends financial

rewards to both quantitative and qualitative

contributions. Proposition 1 posits that when an

analyst’s reputation for delivering high-quality

research falls below a critical threshold (),

employers opt for an Ethics-Driven Contract, relying

on the analyst’s intrinsic motivation or work ethic to

ensure the provision of qualitative information.

Conversely, for analysts with an established

reputation for high-quality research, the Qualitative

Information Incentive Contract incorporates

substantial monetary rewards to incentivize the

inclusion of qualitative insights.

Proposition 1 thus highlights how analysts'

productivity and status shape the design of incentive

contracts. Specifically, our findings show that

reputation reflects analysts’ abilities and correlates

with higher compensation, aligning with empirical

evidence linking pay to performance for financial

analysts (e.g., Eccles and Crane, 1988; Stickel, 1992;

Fang and Yasuda, 2009). In this framework, analysts’

reputational concerns further influence incentives to

deliver valuable and accurate reports. The Qualitative

Information Incentive Contract allows employers to

offer analysts significantly higher compensation,

A similar assumption is made in Heinle, Hofmann & Kunz (2012).

recognizing their prestige. Consistent with evidence

that star analysts command substantially higher

salaries than their lower-status counterparts, analysts

with a strong reputation for high-quality research

receive financial incentives for both quantitative and

qualitative information, effectively motivating their

performance. However, this lucrative compensation

linked to performance can create conflicting

incentives. In contrast, non-reputable analysts, who

must establish a reputation for delivering quality

research, rely more on intrinsic motivation or ethical

concerns to deliver qualitative information.

Consequently, employers are more likely to offer

them Ethics-Driven Contracts.

2.2. First period equilibrium

Based on the second-period contractual, we

calculate the first-period equilibrium research effort.

The analyst’s research effort in the first period is

determined according to the following program



󰇛󰇜󰇛󰇜, s.t. ρt+1 = ρ (ρt,θt)

We thus have (see appendix 5.2):

󰆓󰇛󰇜

󰆓󰇛󰇜󰇛󰇜 (9)

and

 󰇣󰆓󰇛󰇜

󰆓󰇛󰇜󰇛󰇜󰇤󰇟󰇠

(10)

where 󰆒󰇛󰇜

󰇟󰇛󰇜󰇠, Δ=1+λ in

the ethics-driven contract or Δ=(1+μ)/2 in the

qualitative information incentive contract, and

Ψt+1=σt+1/√2.

2.3. Stationary equilibrium

Condition 1.

Under assumption 1, there exists a unique

equilibrium contract if and only if

either 󰇛󰇜󰇛󰇜

󰇛󰇜󰇛󰇛󰇜  and the

optimal contract is an Ethics-Driven Contract

or 󰇛󰇜󰇛󰇜

󰇛󰇜󰇛󰇛󰇜  and the optimal

contract is a Qualitative Information Incentive

Contract

where  

󰇛󰇜, 



 ,  

,

D=(2η(1-η)ΔΨ-η(1+γ))²+4(1-η))(1-ΔΨ(1-η))(γ η+

ΔΨ η²)>0

and Δ=1+λ in the ethics-driven contract or

Δ=(1+μ)/2 in the qualitative information incentive

contract.

We then have the following result.

Proposition 2.

Under condition 1, the economy has a unique

stationary equilibrium. The Ethics-Driven Contract is

implemented when an analyst's productivity - and

consequently their reputation - falls below the

threshold level  . Conversely, the Qualitative

Information Incentive Contract is employed when the

analyst's productivity and reputation exceed this

threshold.

Proof: Immediate from Condition 1.

Proposition 2 illustrates that financial analysts with

high productivity or strong reputations are provided

financial incentives for both quantitative and

qualitative information. In contrast, analysts with

lower productivity or weaker reputations receive

monetary incentives exclusively for quantitative

information, with qualitative contributions being

driven by ethics-based incentives. This suggests that

ethical considerations function as a substitute for

reputation within the incentive frameworks designed

for analysts. Given the intricate interplay of

parameters influencing the model's endogenous

variables, numerical simulations are essential to

effectively compare research efforts and

compensation across the various incentive regimes.

2.4. Comparison of Research Levels and Wages

As reported in figure 1, we see that the Qualitative

Information Incentive Contract is characterized by

lower research effort at date t and a high expected

wage at date t + 1 (Figure 1, case a). On the contrary,

the Ethics-Driven Contract is characterized by a high

research effort at date t and a low expected wage (tied

to the quality of the analysts’ research) at date t + 1

(Figure 1, case b).

Our simulations show that implementing a contract

that leverages ethical distress ensures analysts exert

substantial research effort at date t. Within the

framework of the Ethics-Driven Contract, the reduced

sensitivity of effort to incentives in the second period

is offset by a heightened research effort relative to the

hypothetical, out-of-equilibrium level that would arise

if monetary incentives were applied uniformly to both

quantitative and qualitative information.

Consequently, this elevated research effort at date t

contributes to an enhanced reputation for the analyst

at date t+1. In summary, the Ethics-Driven Contract

capitalizes on analysts' intrinsic "work ethic" to

incentivize the production of valuable and reliable

research, achieving a high research-reputation

equilibrium.

Alternatively, under the Qualitative Information

Incentive Contract, the higher sensitivity of effort to

incentives at date t + 1 coupled with the prospect of a

higher expected wage, results in reduced research

effort at date t compared to the hypothetical, out-of-

equilibrium level that could be achieved through non-

monetary incentives for qualitative information. This

diminished effort at date t undermines the analyst's

reputation for delivering valuable reports and

recommendations at date t + 1. This finding indicates

that a Qualitative Information Incentive Contract

exposes analysts to conflicts of interest. Specifically,

the emphasis on short-term gains—manifested as the

higher wage anticipated at date t+1 distracts analysts

from producing high-quality research, thereby

adversely affecting their reputation. This dynamic

gives rise to a low research-reputation equilibrium.

Our findings highlight the impact of compensation

structures on analysts' effort decisions, taking into

account the roles of reputational considerations and

intrinsic work ethic. The key insight is that the

structure of compensation contracts, when influenced

by reputational concerns and ethical considerations,

can lead to incentive misalignments and suboptimal

decision-making among analysts. Specifically, we

argue that when compensation contracts emphasize

financial rewards for producing high-quality research

(as opposed to relying on ethical pressures), analysts

face a trade-off between short-term financial gains and

long-term reputational concerns. This trade-off often

results in analysts "liquidating" their reputation.

In this framework, the prospect of higher short-term

rewards—such as the increased wages provided by

Qualitative Information Incentive Contracts—

encourage analysts to act opportunistically, resulting

in a deterioration of research quality and a subsequent

erosion of their reputation. The theory of analyst

conflicts of interest suggests that analysts with

established reputations for delivering high-quality

research are more likely to resist opportunistic

behaviors to preserve the long-term benefits of their

reputation. Yet, our findings suggest the opposite:

Conflicts of interest have a more pronounced negative

effect on analysts with strong reputations. The lure of

lucrative compensation intensifies the temptation for

these analysts to trade their reputation for immediate

financial gains, challenging the theoretical

effectiveness of personal reputation as a disciplinary

mechanism. In contrast to Fang and Yasuda (2009)

who argue that personal reputation can effectively

deter conflicts of interest, our results show that the

significant compensation associated with full financial

incentive contracts weakens analysts' motivation to

uphold research quality and preserve their reputation.

In contrast, analysts driven by ethical considerations

in their research are more likely to produce accurate

work. This implies that compensation structures that

align with analysts' work ethic help mitigate the

pressures of conflicts of interest or enable analysts to

better resist them.

Overall, we find that Qualitative Information

Incentive Contracts exacerbate conflicts of interest,

harming both long-term reputation and research

quality. In contrast, Ethics-Driven Contracts, which

emphasize analysts' ethical motivations, help mitigate

conflicts and foster a high research-reputation

equilibrium.

Parameters value: σ=0.1 η=0.7 γ=0.3

CASE (A): ANALYST’S PRODUCTIVITY LEVELS

CASE (B): EXPECTED WAGE LEVELS

FIGURE 1: SIMULATIONS ON RESEARCH LEVELS AND

EXPECTED WAGES (CASE A,B)

3. Conclusion

In response to scandals in the U.S. and growing

global concern over analyst research practices, the

SEC implemented a 2003 settlement requiring

securities firms to significantly separate research

activities from investment banking, particularly in

terms of analysts’ compensation. It is widely

acknowledged that conflicts of interest exist in analyst

research, and recent empirical studies have explored

the role of reputation in addressing these conflicting

incentives.

This paper develops a dynamic model that

examines the interplay between work ethic,

reputational concerns, and incentives in analyst

research. Our central premise is that while potential

conflicts of interest exist, they are unlikely to be

exploited unless incentivized by the compensation

structure. Specifically, we propose that employers can

offer either an Ethics-Driven Incentive Contract or a

Qualitative Information Incentive Contract,

depending on analysts' reputational and ethical

considerations.

By exploring the dynamic relationship between

compensation contracts and analysts’ effort in

delivering high-quality research, this study highlights

the role and limitations of reputation in mitigating

conflicts of interest. Our findings reveal that full

financial incentive contracts, which offer extrinsic

rewards for both quantitative and qualitative

information, tend to amplify conflicts of interest. The

promise of lucrative compensation under these

contracts often discourages analysts from putting in

the necessary research effort, ultimately undermining

their reputation for providing valuable insights to

investors.

Conversely, contracts that combine monetary and

non-monetary rewards based on an analyst’s work

ethic lead to greater research effort and support the

development of a strong long-term reputation. This

analysis underscores the critical relationship between

ethical and reputational concerns and incentives as a

key driver of research quality. In the absence of ethical

considerations, the temptation of short-term financial

rewards may prompt even high-reputation analysts to

compromise their reputation for immediate gains,

resulting in less accurate research.

Conflicts of interest

The author(s) states that there is no conflict of

interests.

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Appendix

A. Optimal Contracts

The contractual relationship is modeled based on the

linear multi-task approach developed by Itoh (1994) and

Feltham & Xie (1994), from Holmstrom & Milgrom

(1987, 1991)’s canonical model.

Observable output is given by y t+1 = e t+1 + q t+1 +

ε t+1

where: e t+1 is the effort for gathering quantitative

information, q t+1 is the effort for gathering qualitative

information and ε t+1 is a random (noise) term with

distribution Ν(0,(σ t+1 )²)

The analyst’s net compensation is ω t+1 = E(w t+1) -

C(e t+1, q t+1)

where C (.,.) is the analyst’s cost of efforts

(equations 8a and 8b) and the analyst’s expected

compensation is E(w t+1 ) = α . Ε( y t+1 ) + β

Parameters α and β are determined so as to maximize

the employer’s expected profits

B t+1 = π(ρ t+1) . Ε( y t+1) - E(w t+1 ), with π(ρ t+1)= ρ

t+1 / [ρ t+1 + (1−ρ t+1) η t+1] .

In this context, the optimal contract is determined in

three steps:

 Step 1 : Incentive compatible constraint : α

such that e t+1 = argMax CE t+1

 Step 2 : Participation constraint: β such that

CE t+1 =0

 Step 3 : Optimal contract: (e t+1 , q t+1 )=

argMax B t+1

Where the analyst’s certain equivalent is defined by

CE = E(w t+1) - C(e t+1, q t+1) – r(α)²(σ t+1 ²/2 ) , with

r the absolute risk aversion coefficient: r = - u”(.) / u’(.)

= 1 / (w t+1 - C(e t+1, q t+1)), given a second period

reservation utility null

Solving step 1, 2 and 3 leads to the following optimal

contracts:

 Qualitative Information Incentive Contract

(QIIC):

et+1 = π(ρ t+1) - Ψ t+1

q t+1 = π(ρ t+1)

E(w t+1) = (π(ρ t+1))²/2 - (Ψ t+1)²(1+λ)/2

B t+1 = (π(ρ t+1))²/2 - π(ρ t+1) Ψ t+1 + (Ψ t+1)²(1+λ) / 2

with Ψ t+1= σt+1/√2.

 Ethics-Driven Contract (EDC):

et+1 = π(ρ t+1)/(1+μ) - Ψ t+1 / 2

q t+1 = π(ρ t+1)/(1+μ) - Ψ t+1 / 2

E(w t+1) = (π(ρ t+1))²/ (1+μ) - (Ψ t+1)²(1+μ) / 4

B t+1 = (π(ρ t+1))²/ (1+μ) - π(ρ t+1) Ψ t+1 + (Ψ t+1)²(1+μ)

/ 4

with Ψ t+1= σt+1/√2.

Proof of Proposition 1.

We compute the difference between expected profits

from the QIIC and expected profits from the EDC, and

find that

(π(ρ t+1))²/2 - π(ρ t+1) Ψ t+1 + (Ψ t+1)²(1+λ) / 2 - (π(ρ

t+1))²/ (1+μ)

- π(ρ t+1) Ψ t+1 + (Ψ t+1)²(1+μ) / 4

= (π(ρ t+1))² (μ-1) / 2 (μ+1) + (Ψ t+1)²(1-μ+2λ) / 4

Given that -1<μ<1, (π(ρ t+1))² (μ-1) / 2 (μ+1) + (Ψ

t+1)²(1-μ+2λ) / 4 >0 iff

(π(ρ t+1))² <(Ψ t+1)²(1+μ)(1-μ+2λ) / 2(1-μ) , that is: π(ρ

t+1) <  





which is equivalent to ρ t+1 <  

󰇛󰇜,

with 



 and Ψ t+1= σt+1/√2.

B. Dynamics of analyst’s research and

productivity

Solving 

󰇛󰇜󰇛󰇜, s.t. ρt+1 = ρ

(ρt,θt) =At (θt)γ (ρt) 1-γ

leads to the following condition: 



󰇛󰇜

 



where 󰇛󰇜

 

 and 



We thus have 



 

 , that is:







Using

ω t+1 = E(w t+1) - C(e t+1, q t+1)

and E(w t+1) = (π(ρ t+1))²/2 - (Ψ t+1)²(1+λ)/2 in the QIIC

and E(w t+1) = (π(ρ t+1))²/ (1+μ) - (Ψ t+1)²(1+μ) / 4 in

the EDC

we get:

ω t+1 = Ψ t+1 π(ρ t+1)- Δ (Ψ t+1)² and 

 

󰆒󰇛󰇜

In turn, we obtain

󰆓󰇛󰇜

󰆓󰇛󰇜󰇛󰇜

where 󰆒󰇛󰇜

󰇟󰇛󰇜󰇠

and Δ = 1+λ in the QIIC , Δ = (1+μ)/2 in the EDC

and Ψ t+1= σt+1 / √2

Then we show that ρt+1 is monotonic and strictly

increasing in ρt

We compute

 󰇣󰆓󰇛󰇜

󰆓󰇛󰇜󰇛󰇜󰇤󰇟󰇠

In turn, we can write:



󰇟󰇠󰇟󰇠󰇩󰆒󰇛󰇜

󰆒󰇛󰇜󰇛󰇜󰇪



󰇟󰇠 󰇩󰆒󰇛󰇜

󰆒󰇛󰇜󰇛󰇜󰇪





󰇩󰆒󰇛󰇜

󰆒󰇛󰇜󰇛󰇜󰇪



 󰇩

󰆒󰇛󰇜

󰆒󰇛󰇜󰇛󰇜󰇪



That is  󰇟󰇛󰇜󰇠

 with 󰇛󰇜



󰆓󰇛󰇜

󰆓󰇛󰇜󰇛󰇜

We show that G’ (ρt+1) < 0  π ” (.) < 0

Given that π(ρ t+1)= ρ t+1 / [ρ t+1+(1−ρ t+1)η t+1] , hence,

function G(.) is strictly decreasing. Using the implicit

function theorem, ρt+1 therefore is monotonic and

strictly increasing in ρt.

For each ρt corresponds a unique ρt+1.