Investment Banking: More Bricks in the Wall

Regulators are introducing new rules to ensure the objectivity of stock analysts, but what's good for investors could be bad for CFOs.

Merrill Lynch vehemently opposed Spitzer’s proposal that its analysts be separated from the rest of the firm, and the attorney general dropped the request. “Merrill Lynch decided it was willing to give up something on the credibility side to hold on to those analysts,” says Crane.

Rise of the Buy Side

Investment adviser Shilling believes that institutional investors will continue to beef up their buy-side analyst teams and start ignoring the sell side entirely. “Eventually, you’ll have a very clear separation between truly independent analysts and the in-house shills who are basically touting the corporate finance list,” he says. He also predicts that sell-side analyst departments will begin to shrink, but not because of analyst conflicts. “Corporate- financing activity is going to continue to go down, creative financing is out, there’s going to be very few corporate deals being done,” says Shilling. “Do you think the investment banking guys are going to eat beans while the analysts are living high? Hell, no. Pay for analysts is going to shrink tremendously, and I predict that a lot of them are going to go to the buy side as a safe haven.”

Crane thinks this is an extreme view and argues that there is still a role for sell-side research, albeit a limited one.

“There are various degrees of credibility,” says Crane. “If you want to know what’s going on with a company’s capital structure or sales growth, get an analyst’s report and you can learn a lot. Often they provide information that [investors] never heard before about a company or an industry. But I’m not going to put 100 percent faith in the fact that that person rated the company a buy. I think we should regard analysts as helpful but, like salespeople, everything they say has a point of view.”

Others foresee the rise of paid-for research, in which investors subscribe to research reports from independent or buy-side analysts, who are widely considered to be far more impartial because they have a vested interest only in predicting the accurate movement of a stock, not touting it. Many hold up the example of money managers Sanford Bernstein as the face of the future for analysis. In fact, paid-research firms and Web sites have proliferated in the past six months.

Goldman says that whereas Siebel was once covered by 10 analysts, it’s now covered by 30–many from new boutique research firms–who often aren’t as knowledgeable as their predecessors at the big firms. “The challenge for CFOs will be dealing with all these analysts,” he says. “The average company’s analyst group is being splintered as investment banks let go of people. Small boutiques are springing up. They have low overhead. The analyst pay is low. These analysts are perceived to be more objective, but a lot of the information that will come out won’t be factual, and it’s much more time-consuming to deal with them.”

Smaller companies may have fewer analysts following them once their ability to bargain for coverage is taken away. As a result, more issuers may commission analyst coverage from specialty investment advisers such as BlueFire Research, which provides equity research for small- and midcap companies. A recent survey by the National Investor Relations Institute found that 10 percent of the respondents had commissioned research, and it wasn’t just small-cap companies that did so; 8 percent of companies valued at $10 billion or higher had commissioned research.


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