October 14, 2009

Financial Analyst Bias and Client Pressure

Bloomberg has published an interesting article by Edward Robinson about the influence that sales representatives of investment banks have had on the financial analysts working at the companies (hat tip to C K Michaelson of Some Assembly Required):
When Credit Suisse Group analyst Ivy Zelman refused to turn bullish on homebuilding stocks during a rally in the fourth quarter of 2006, the blowback was intense.

She says investors told her that some housing industry executives were ridiculing her analysis as a “jihad,” and several of the bank’s sales representatives pressed her to upgrade “hold” ratings to “buys” on companies to appease bullish institutional-investor clients. One sales manager even sent her an e-mail warning that analysts who stayed bearish too long often lost their jobs.
The article goes on to explain how very biased analysts in general are against handing out "sell" recommendations for stocks.

The pressure that is applied on analysts that make "sell" recommendations has been documented before. Start analyst Meredith Whitney even got death threats for giving out a pessimistic but accurate analysis of Citigroup in late 2007.

The reference to "appeasing insitutional-investor clients" is a dead giveaway of the cause of this pressure. These clients are not after sound advice. They have already made their minds. What they are after is a blanket of security in the form of advice that just happens to agree with their prior decisions.

If things go wrong, these institutional investors (read retirement fund managers) can just explain that they relied on the investment bank analyst's analysis. This partly relieves them from the responsibility for the bad investments.

Maybe it would not be a bad idea to prevent companies that handle client money or have proprietary trading desks from publishing any analysis or advice at all. At least fund managers shouldn't be able to hide behind advice from parties that are completely dependent on them as clients.

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