Business Exposed92
a company higher than their
peers at other investment banks
if this rm was also a client.
This was true when the rating
was issued before the deal – at a
time when the bank’s corporate
nance department was likely
bidding or at least eyeing up a potential client – but also after a
deal had been awarded, when the company was now ofcially a
customer, and apparently able to exercise power. However, the
closer the issue date of the rating to the deal date, and the larger
the client, the stronger this inuence was.
While the Great Wall of China might have been helpful at
keeping the Hun tribes out of China, the mythical Chinese
walls inside our professional corporations are apparently much
worse at curtailing the inuence of powerful stakeholders. Their
presence can be measured and felt – at the end of the day, all the
way into their shareholders’ pockets.
Banks’ blurry categorizations – have your cake and
eat it too
“Animals are divided into (a) those that belong to the Emperor, (b)
embalmed ones, (c) those that are trained, (d) suckling pigs, (e) mermaids, (f)
fabulous ones, (g) stray dogs, (h) those that are included in this classication,
(i) those that tremble as if they were mad, (j) innumerable ones, (k) those
drawn with a very ne camel’s hair brush, (l) others, (m) those that have just
broken a ower vase, and (n) those that from a long way off look like ies.”
This categorization was quoted by Jorge Borges in his book Other
Inquisitions, from an ancient Chinese encyclopedia. I’m glad
that in the world of business, when it comes to analyst recom-
mendations whether to buy, sell or hold the shares of certain
companies, we use rather more unambiguous classications,
don’t we! Or do we?
As I previously discussed, analysts often face a potential conict
of interest. In principle, they are expected to offer solid and
‘‘
in 80 percent of cases,
analysts would rate a company
higher than their peers at
other investment banks if this
firm was also a client
’’
935
n
Liaisons and intrigues
impartial advice on whether they think it’s worth buying the
shares of a particular company (because they forecast that the
share price will go up) or whether they think it is time to ofoad
any stock you bought in the past (because they forecast that its
price will go down). However, their employer – the investment
bank – quite often also serves this company as a client, for
instance to advise them on their M&A, equity, and debt deals.
The tricky thing is, companies don’t like it (and this is a
euphemism) when their own investment bank issues a negative
(i.e., “sell”) recommendation for their shares.
So, how do investment banks deal with this? As discussed, in the
past, they often simply didn’t. They would shamelessly issue a buy
recommendation for a company just to secure it as a client. However,
lately, this has become more and more tricky for a bank, to say the
least. That’s because the truth can eventually come out (we’ve seen
examples of informal e-mail exchanges between bank employees in
which they mock clients who they formally recommended to buy),
but also because brokerage watchdogs have become focused on such
behavior. More than ever, banks’ long-term reputations can suffer if
they make recommendations (e.g., buy) which later turn out to be
quite wrong, loss-making, or plain stupid.
So, how do banks resolve this tricky dilemma? Anne Fleischer –
an assistant professor at the University of Toronto – undertook
an intriguing piece of analysis. She looked at ambiguity in banks’
equity ratings systems and how it was related to such conicts
of interest.
You have to realize that banks use different classication schemes
in their advice regarding the attractiveness of certain stocks,
and these vary in terms of how ambiguous they can be. For
example, buy; sell; hold is simple enough isn’t it? But many
rms use ve categories, including a strong buy and clear sell.
Still pretty unambiguous, right? But what about “buy/high risk”
versus “buy/low risk”; a bit trickier, no? Or “buy; positive; hold;
neutral; negative”? Or what about the difference between “buy”
and “accumulate” (also found within one and the same classi-
cation scheme)?! Some banks have up to 16 different categories,
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