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Security Analysts and Conflicts of InterestPresentation Transcript
Security Analysts and Conflicts of Interest Jay R. Ritter Cordell Professor of Finance University of Florida
Security analysts who work for brokerage firms that do investment banking, trade stocks (brokerage), and provide research on these stocks are known as “sell-side” analysts I will focus exclusively on equity analysts
We don’t make money by selling our research papers to PBFJ and other journals
We get paid indirectly through a higher salary if we publish influential research papers
Security analysts are paid indirectly if they attract
- investment banking deals
- trading commissions that include soft dollars
Soft dollars are investor commissions paid for services in excess of pure trade execution.
Conflicts of interest
Need to get information from management
Need to appease investors long in stock
Need to attract banking mandates
What do practitioners think?
“ If an analyst is negative on you, you are not going to hand their bank a significant role in your stock issuance, that’s for sure. That person becomes the mouthpiece to the investment community for your firm.”
Amylin Pharmaceuticals CFO Mark Foletta,
as quoted in Investment Dealer’s Digest .
These conflicts create an incentive to issue optimistic recommendations During the TMT (Tech, Media, and Telecom) bubble of the late 1990s, these conflicts of interest became severe
Where were the regulators?
Recent years have seen major changes
The commissions per share paid by institutional investors in the US have collapsed in the last seven years from an average of about 4.5 cents per share to about 1.5 cents per share
This is a weighted average of ECNs, “crossing networks”, and full-service brokers
Proportion of buy, hold, and sell recommendations from U.S. sell-side analysts, 2000-2004. Source: Reuters Estimates
The Financial Services Authority (FSA) in the UK has encouraged unbundling
The salaries of sell-side analysts have been falling Many sell-side analysts have moved to the buy-side In Europe and North America, junior analyst jobs have been outsourced to India More research is being offered on Asian stocks
What are the most important qualities of a good analyst? a) Accurate earnings forecasts b) Timely buy and sell recommendations c) Insightful written reports d) Setting up meetings with management e) Accessibility/responsiveness of phone calls f) Industry knowledge
Private value of information Investors are willing to pay for information only when it is valuable Value can be measured as the ability to generate positive abnormal returns
The private value of public information is zero
The private value of private information can be considerable
This distinction is at the heart of the conflicts of interest problem
Academic research Grossman and Stiglitz (1980 AER ) “The Impossibility of Informationally Efficient Markets” --There is an equilibrium degree of inefficiency
Affiliated: Managing syndicate members
Non-managing syndicate members
Are conflicts of interest different for affiliated and unaffiliated analysts?
Bradley, Jordan, and Ritter (2008 RFS ) “Analyst Behavior Following IPOs: The ‘Bubble Period’ Evidence”
Academic research focuses on public, measurable info like EPS forecasts Institutional investors don’t care about this info But are these measurable variables correlated with useful telephone calls?
A good book
Confessions of a Wall Street Analyst (2006)
by Dan Reingold with Jennifer Reingold
Dan Reingold was an II all-star analyst
who covered telecoms from 1984-2003
Analyst conflicts are difficult to regulate because of the economics of information
Information has different public and private value, so there is an externality
Academics are able to measure the public pronouncements, which institutional investors don’t care about