Monday, December 03, 2007

A corollary to the Doctrine of Original Sin

is that Conflicts of Interest Cannot Be Eliminated:
According to Bloomberg, just 7% of all analyst recommendations this year have been “sell,” below even the paltry 11% in 2003, the year the industry’s practices spawned a $1.4 billion penalty from then-New York Attorney General Eliot Spitzer. Indeed, not a single one of the top analysts following a sector they should know a thing or two about — securities — has slapped a sell rating on any of the troubled firms in the industry, the article points out.

The reason analysts still aren’t that skeptical? It may be that they simply have traded one master for another. In the dot-com bubble days, it was fear of losing investment-banking business for their firms that kept analysts from telling their clients to sell stocks. Now, with bankers and analysts effectively divorced, it appears a fear of alienating the brass at the companies they analyze is motivating researchers.

You might expect investor clients known as the “buy side,” who supply Wall Street analysts with billions in commissions every year, to force them to come clean. But according to a recent Greenwich Associates study, they don’t really care about ratings. There is something else they want from analysts. As one hedge-fund manager tells Bloomberg:

“An analyst cannot issue a sell rating because he doesn’t want to lose access….It’s logistically cumbersome for the buy-side to arrange its own meetings with company management, so this concierge service is very useful.”

This corollary also applies to ratings agencies and financial auditors, who are paid by the objects they are supposed to be holding accountable.

UPDATE: Another corollary, from Russ Roberts, is If I'm Splitting Costs With You, I'm Ordering the Expensive Stuff.

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