Brookings-Wharton Papers on Financial Services 2002 (2002) 125-127
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Jay Ritter announced his strong support for the new Regulation Full Disclosure and his belief that, at least in theory, it has leveled the playing field in the markets between large and small investors. Nonetheless, Ritter asserted that the Securities and Exchange Commission is not enforcing the regulation. He also suggested that the investment banking industry is vertically integrated because investment banking is very information-intensive, as there are natural economies of scope in making use of information that is already in these firms' possession.
Robert Litan asked the authors whether they distinguished between the lead underwriter and participating underwriters in their studies.Womack replied that they only looked at the lead underwriter, since that is the firm whose reputation is on the line. The authors considered other firms in the syndicate to be unaffiliated and did not distinguish the data further since it would be difficult to find entirely unaffiliated analysts given the size of most syndicates. One participant felt that by considering only the lead underwriter the authors strengthened their case, since firms not in the syndicate, but wanting to get into it, would be even more willing to give optimistic findings.
Another participant claimed that the market is the real check on analysts that are biased in a dishonest way. He stated that, as a sell-side analyst, his credibility with investors is derived not by one trade but by his ability to give good advice over a long period of time; hence if his track record is poor, his firm will fire him. For example, certain well-known analysts whose credibility has been damaged are no longer employed in the industry.
Rich Lyons wanted to know whether buy and sell recommendations are evenly balanced in foreign exchange, Treasury bonds, or corporate debt. [End Page 125] He was especially interested in corporate debt, since underwriting fees are involved, but the firms are much less sensitive to a potential loss of value relative to equity. Womack replied that the difference is that most of the time managers themselves have significant ownership interests in stock, whereas they probably do not have significant ownership in bonds or foreign exchange. Leslie Boni disagreed with her co-author on this point. She said that investment banks run large foreign exchange speculative trading positions and could have a lot at stake in the positions they are recommending to their clients. She felt that this question deserves future research.
Frank Edwards phrased the credibility problem as the failure of the reputational effect to discipline liars. He felt that the authors should explain why this effect fails to work. One participant claimed that the effect does work because it is impossible for an analyst to remain employed while putting out recommendations that consistently cause clients to lose money. Edwards followed up by suggesting that the market in reputation must work if one accepts the authors' contention that institutions are not fooled by buy recommendations. However, there are notable cases where institutional buyers are fooled, Enron being perhaps the best example.
John Coffee suggested that the authors expand their focus from harm to the retail investor to the volatility of earnings and the credibility of financial reporting. He argued that there are connections between optimistic analyst forecasts and recent studies showing that earnings restatements were up 47 percent over the last three years. He put forth the following scenario: managements give optimistic projections to analysts, who then inflate these even more due to conflicted advice at the margin, causing corporate officers to manage their companies' earnings in order to hit or exceed the projections. Eventually some officers are caught when auditors draw the line and force an accounting restatement. The availability of a liability "safe harbor" for forward-looking information means that there is almost no legal liability today for these kinds of projections.
Paul Mahoney attempted to reconcile the disproportionate number of buy recommendations with the fact that those recommendations may contain some information by suggesting that if analysts can control the timing of their buy recommendations...