Balanced but not fair: Strategic balancing, rating allocations, and third-party intermediaries

Abstract

This article examines how two fundamental features of many intermediaries—that intermediaries provide ratings across a set of candidates (their portfolio), and that intermediaries wish to look credible to their audiences—may create the potential for bias in evaluation outcomes. I examine how having too many positive ratings, which risks intermediary credibility, may bias an intermediary in favor of giving a subsequent negative rating, which I term strategic balancing. My setting is the ratings given by equity analysts on publicly traded firms. I find evidence consistent with a strategic balancing effect, such that having a greater allocation of high ratings in an analyst’s portfolio is associated with a subsequent negative rating, particularly when such ratings can be justified. My findings suggest that lower ratings may not be the result of poor firm performance, but instead may occur because such a rating allows an intermediary to maintain credibility. That is, the very features that define the role of the intermediary—one who interprets many market offerings for a particular audience—can create the conditions in which its evaluations may be subjective.