Business Exposed94
advising us to buy or not. But why would they create such
opaque, blurry schemes to advise us in the rst place?
Might it have anything to do with covering their back when they
face a conict of interest. . . ? Could it perhaps enable them to get
away with not offering unambiguous sell advice on a client (risking
pissing them off) while in reality their analysts are pessimistic
about the company’s prospects? After all, if they recommend an
unambiguous buy but the share price plummets, they will look
incompetent, if not worse. However, what if they had recommended
us a “speculative buy”? Guess that might divert the blame a bit and
get them off the hook. Perhaps such ambiguous schemes help banks
make blurry recommendations that keep both angry investors and
overbearing clients at bay? Would banks really be that devious?
Anne didn’t just think; she looked at the facts. She had some
nancial specialists rate how ambiguous the rating schemes
were of 207 brokerage rms. Then she computed to what extent
these rms faced a potential conict of interest, because they
were both providing purchase advice and securing the same
companies as clients underwriting their debt and equity offerings
or supporting their M&A activity. The results were clear: those
investment banks that faced a conict of interest developed more
ambiguous classication schemes to “advise” us on the purchase
and sale of company shares.
Evidently, these equity rating systems are not
just created with the aims of unequivocal
advice and clarity in mind. Quite the
contrary; sometimes banks don’t want to
create clarity at all. Blurring the boundaries
helps them cover their tracks, make money
on both sides of the table, and thus have
their cake and eat it too.
Analysts rule the waves (whether we like it or not)
I will briey return to the topic of conicts of interest a little
later, but let me now elaborate a bit on the inuence of equity
‘‘
sometimes
banks don’t want
to create clarity at
all
’’
955
n
Liaisons and intrigues
analysts. Their inuence on a rm’s stock price is known to be
substantial, as one would expect from a nancial analyst. Thus,
they determine the amount of nancial resources available to a
rm. However, their impact actually goes quite a bit further than
that: because of their power to determine a company’s access to
nancial means, they also have a substantial inuence on what
sort of strategy the rm is pursuing in the rst place. A good
setting to illustrate this is corporate diversication.
In the 1960s we saw a wave of “diversication” among corpora-
tions, resulting in the emergence of many so-called conglomerates.
They operated in all sorts of businesses that often didn’t have
much to do with each other. For example, a famous conglom-
erate in the UK was Hanson plc, whose divisions operated in
activities ranging from chemical factories to electrical suppliers,
gold mines, cigarettes, batteries, airport duty-free stores, clothing
shops, and department stores. Diversication was popular and
conglomerates ourished.
In the 1990s though, the trend reversed, and we witnessed a wave
of de-diversication. Firms started to focus on their “core activ-
ities”, companies were split up, conglomerates were dismantled,
and diversication was generally regarded as unfashionable, evil,
and simply not done.
What led the trend to reverse? Economists have argued that
it was shareholders ghting back. Shareholders can diversify
their stock portfolios; they don’t need companies to do that for
them. Managers only do so to serve their own needs, and feed
their desire for empire-building, size, and security. In the 1990s,
shareholders said “basta” and forced self-serving managers to
de-diversify – or so they claim.
A slightly kinder view is offered by sociologists, who argue that
in the 1960s it was considered good practice to spread risk and
diversify and hence a “legitimate thing to do”. Managers weren’t
selsh and evil; they simply did what was expected of them. When
shareholders said, “We don’t want you to do this anymore” (perhaps
because the market became more transparent and efcient), they
diligently responded and applied more focus to their companies.
Business Exposed96
Yet, more recently, researchers have started to focus on the role
that analysts played and still play in discouraging companies
to spread their activities across different industries. After all,
sometimes diversication might make sense! For example, a
company like Monsanto sort of had to operate in pharmaceu-
ticals, agricultural chemicals, and agricultural biotechnology
because its expertise bridged these different areas and therefore it
was advantageous to operate in all of them. But that something
makes sense from a strategy perspective doesn’t mean it makes
sense in light of an analyst’s lunch-break.
What do analysts’ lunch-breaks have to do with any of this, you
might wonder.
Well . . . it is very important for listed rms to be covered by
analysts. We know from ample research that rms who receive less
coverage usually trade at a signicantly lower share price. Consider
this quote, from an analyst report by PaineWebber in 1999:
“The life sciences experiment is not working with respect to our analysis
or in reality. Proper analysis of Monsanto requires expertise in three
industries: pharmaceutical, agricultural chemicals, and agricultural
biotechnology. Unfortunately, on Wall Street, these separate industries are
analyzed individually because of the complexity of each. At PaineWebber,
collaboration among analysts brings together expertise in each area.
We can attest to the challenges of making this effort pay off: just co-
ordinating a simple thing like work schedules requires lots of effort.
While we are willing to pay the price that will make the process work, it
is a process not likely to be adopted by Wall Street on a widespread basis.
Therefore, Monsanto will probably have to change its structure to be more
properly analyzed and valued.”*
Wait a second, did they just suggest that Monsanto should split
up because it requires three (industry-specic) analysts to cover
them and these three jokers can’t nd a mutually convenient
time to meet?! Yes, I am afraid they did.
* Adapted with permission from by Corporate Strategy, Analyst Coverage, and the
Uniqueness Paradox by Litov, Moreton, and Zenger, Washington University at St
Louis. See http://papers.ssrn.com/.sol3/papers.cfm?abstract id=1364037#http://
paper.ssrn.com/sol3/papers.cfm?abstract id=1364037
..................Content has been hidden....................
You can't read the all page of ebook, please click here login for view all page.