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Nearly two thirds of stock analysts receive favors from execs of firms they cover -- and it affects their ratings, study suggests

July 1, 2007

For more information, contact: Benjamin Haimowitz,

Not long ago, the CEO of a large U.S. company showered a series of favors on a stock analyst who covered the firm. Within a matter of months he recommended the analyst for a job; put him in touch with top managers of two supplier firms and a buyer firm; provided career advice on two occasions; offered to meet with the analyst's clients; and shared with him valuable information about recent technological developments in his industry.

This remarkable solicitousness by a busy chief executive occurred in the wake of a company earnings announcement that was well below consensus forecasts. Perhaps not surprisingly, the analyst did not subsequently lower his rating of the firm's stock.

Seven years after the Securities and Exchange Commission instituted Regulation FD, requiring that any information provided to one analyst by a company be available to all, other kinds of executive favors to stockpickers are rampant in the corporate world, according to a study to be presented at the annual meeting of the Academy of Management (August 5-8 in Philadelphia).

Based on a survey of several thousand analysts -- and follow-up confirmation with corporate higher-ups -- the study finds that close to two thirds of the stockpickers, 63 percent, received favors from CEOs, CFOs, and other top executives -- an average of three per recipient over periods ranging from a month to a year.

The study, by James D. Westphal of the University of Michigan and Michael Clement of the University of Texas, Austin, reveals that the more a firm's earnings dip below consensus forecasts, the more favors the firm's executives proceed to bestow on the analysts covering the company. Particular targets, it finds, are analysts that have All-America status or work for large brokerage firms.

Even more important, the favors appear to be highly effective: rendering two personal favors for an analyst after the release of relatively low reported earnings reduces the likelihood that the analyst will issue a downgrade by half. In the wake of a diversifying acquisition, a move generally frowned upon by Wall St., it reduces the likelihood of a downgrade by 65 percent.

As effective as granting favors, the professors report, is withholding them or singling out analysts for disfavor, such as by refusing to respond to phone calls or to answer questions from analysts who recently downgraded the company's stock. According to Prof. Westphal, stockpickers who knew of instances of retaliation from an executive within the past two years were less than half as likely as other analysts to downgrade that executive's company in response to reported earnings 50% below consensus forecasts.

The most-reported favor bestowed by executives, accounting for 28% of the total, was putting an analyst in touch with a top manager of another firm. Ranking second, accounting for 20% of the total, was an executive's providing an analyst with career advice, followed by an executive's offering to meet with an analyst's clients (13%), providing advice on a personal matter (11%), relaying industry information (10%), recommending an analyst for a job (8%), and helping an analyst gain access to a private club or nonprofessional organization (6%).

The new study's findings are based upon answers to 4,500 questionnaires mailed to analysts between 2001 and 2003 and follow-up surveys sent to executives of the companies they cover, all with sales of more than $100 million. One survey asked analysts about favors received from top executives of a specific company they covered since the date of its most recent earnings announcement; a second asked about favors since the date of an announcement of a diversifying acquisition; a third asked analysts about the effects of stock downgrades, either by them or other analysts, on favoring-rendering by executives and access to executives. Response reliability was assessed through follow-up questionnaires to the top executives that the analysts identified in their answers.

"Survey questions about executive favors were a small part of a larger questionnaire about personal and professional helping behaviors toward fellow analysts or executives," Westphal and Clement explain. "Most of the survey questions...were about behaviors with manifestly positive connotations, and the overall subject of the surveys (helping behavior toward colleagues) likewise had positive connotations." About 40% of analysts and executives responded to the questionnaires, a high rate.

Westphal says that in interviews he conducted with analysts he detected little sense of wrongdoing about accepting favors from top executives of companies about which they were paid to make disinterested judgments. "There's a certain prestige in getting favors from important executives," he says. "The general view seems to be that this is a plus, because it helps get valuable info about the companies."

Westphal and Clement take a more negative view. "Our findings have important implications for corporate control and the efficiency of capital markets," they write. "[M]icro-social factors in manager-analyst relations, by reducing the objectivity of security analysts' stock recommendations, may ultimately compromise corporate control and financial-market efficiency."

Adds Clement: "What we're talking about here is certainly not as blatant as bribery. nor does it have an instant payoff, like getting a piece of privileged information. But it is more than just socializing -- in fact, in our analysis we controlled for the level of social interaction between analysts and executives.

"The bottom line is that favor-rendering to analysts is evidently widespread and that it seems to be compromising the value of the guidance these experts provide to investors. While there may be no simple solution to the problem, our findings certainly suggest that it deserves to be taken seriously, whether by the securities industry or by government."

The study, "Sociopolitical Dynamics in Relations Between Top Managers and Security Analysts: Favor Rendering, Reciprocity, and Analyst Stock Recommendations," will be among several thousand studies presented at the Academy of Management meeting. Founded in 1936, the Academy is the largest organization in the world devoted to management research and teaching. It has about 18,000 members in 100 countries, including some 10,000 in the United States. This year's annual meeting will draw about 8,000 scholars and practitioners to Philadelphia from August 5th to 8th for nearly 1,700 sessions on a host of subjects relating to corporate organization and investment, the workplace, technology development, and other management-related topics.

Media Coverage:
Associated Press. New study shows Wall Street favors. (Friday, July 27, 2007). Analysts and CEOs: A love story?. (Friday, July 27, 2007).
CNBC. On the Money: Interview with Financial Times' Francesco Guerrera. (Friday, July 27, 2007).
Crain's Hey, analyst. I'll trade you a club membership for a good rating. (Friday, July 27, 2007).
Financial Times. Executives find favors bring better ratings. (Friday, July 27, 2007).
Reuters. Lifting the lid: CEO-analyst ties run deep. (Friday, July 27, 2007).
The Economist. Trading favors. (Saturday, July 28, 2007).
USA Today. Favors for Wall Street analysts often benefit firms. (Friday, July 27, 2007).

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