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Security Analysts and Conflicts of Interest. Jay R. Ritter Cordell Professor of Finance University of Florida.

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Security Analysts and Conflicts of Interest

Jay R. Ritter

Cordell Professor of Finance

University of Florida


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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” analystsI will focus exclusively on equity analysts


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What do security analysts do? investment banking, trade stocks (brokerage), and provide research on these stocks are known as “sell-side” analysts

Public pronouncements

  • Buy/sell recommendations

  • Target prices

  • Earnings forecasts

  • Written reports


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What do security analysts do? investment banking, trade stocks (brokerage), and provide research on these stocks are known as “sell-side” analysts

Private (telephone calls)

  • Summarizing information

  • Passing along private (inside) information


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Sell-side security analysts are like professors investment banking, trade stocks (brokerage), and provide research on these stocks are known as “sell-side” 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


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  • Security analysts are paid indirectly if they attract investment banking, trade stocks (brokerage), and provide research on these stocks are known as “sell-side” analysts

    - investment banking deals

    - trading commissions that include soft dollars

  • Soft dollars are investor commissions paid for services in excess of pure trade execution.


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Conflicts of interest investment banking, trade stocks (brokerage), and provide research on these stocks are known as “sell-side” analysts

  • Need to get information from management

  • Need to appease investors long in stock

  • Need to attract banking mandates


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What do practitioners think? investment banking, trade stocks (brokerage), and provide research on these stocks are known as “sell-side” analysts

“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.


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These conflicts create an incentive to issue optimistic recommendationsDuring the TMT (Tech, Media, and Telecom) bubble of the late 1990s, these conflicts of interest became severe



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Recent years have seen major changes recommendations

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


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Proportion of buy, hold, and sell recommendations from U.S. sell-side analysts, 2000-2004.

Source: Reuters Estimates



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The salaries of sell-side analysts have been falling encouraged unbundlingMany sell-side analysts have moved to the buy-sideIn Europe and North America, junior analyst jobs have been outsourced to IndiaMore research is being offered on Asian stocks


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What are the most important qualities of a good analyst? encouraged unbundling

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


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Private value of information encouraged unbundling

Investors are willing to pay for information only when it is valuable

Value can be measured as the ability to generate positive abnormal returns


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The private value of public information is zero encouraged unbundling

The private value of private information can be considerable

This distinction is at the heart of the conflicts of interest problem


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Academic research encouraged unbundlingGrossman and Stiglitz (1980 AER) “The Impossibility of Informationally Efficient Markets” --There is an equilibrium degree of inefficiency


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Underwriters encouraged unbundling

Affiliated: Managing syndicate members

  • Lead underwriter(s)

  • Co-managers

    Unaffiliated

  • Non-managing syndicate members

  • All others


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Are conflicts of interest different for affiliated and unaffiliated analysts?

  • Incumbent’s advantage

  • Currying favor

    Bradley, Jordan, and Ritter (2008 RFS) “Analyst Behavior Following IPOs: The ‘Bubble Period’ Evidence”


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Academic research focuses on public, measurable info like EPS forecastsInstitutional investors don’t care about this infoBut are these measurable variables correlated with useful telephone calls?


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A good book EPS forecasts

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


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Summary EPS forecasts

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


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