Security Analysts and Conflicts of Interest. Jay R. Ritter Cordell Professor of Finance University of Florida.
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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” analystsI will focus exclusively on equity analysts
Private (telephone calls)
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
- investment banking deals
- trading commissions that include soft dollars
“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 recommendationsDuring the TMT (Tech, Media, and Telecom) bubble of the late 1990s, these conflicts of interest became severe
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 salaries of sell-side analysts have been fallingMany 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
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
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 private information can be considerable
This distinction is at the heart of the conflicts of interest problem
Academic researchGrossman and Stiglitz (1980 AER) “The Impossibility of Informationally Efficient Markets” --There is an equilibrium degree of inefficiency
Affiliated: Managing syndicate members
Bradley, Jordan, and Ritter (2008 RFS) “Analyst Behavior Following IPOs: The ‘Bubble Period’ Evidence”
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?
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