Let’s face it; analysts are just a very strange phenomenon in our global economy. These people advise us to buy, sell or hold particular companies’ stock but we also all know that the banks that employ them make money if we buy. More importantly, we know that these very same companies that they advise us on are the banks’ customers (e.g. for their M&A deals), which makes it a rather hefty conflict of interest (especially when the real advice should be “sell, now!”). Moreover, on what information do these analysts base their recommendations? 1) The same o-so-reliable numbers as the rest of us have too, and 2) talking to the company’s sweet-talking CEO. Ooo… that’s comforting…
That is of course a nice, glamorous perk for the average analyst; being invited to personal audiences with a real-life CEO. Mind you though, if you subsequently don’t write nicely about their company, they won’t invite you back! That’ll teach you!
Or do you think I am exaggerating now, and really starting to create a gimmicky parody of what really is a very serious financial business? Well, let me tell you a story. And it is a story about facts.
Professor Jim Westphal from the University of Michigan and Michael Clement from the University of Texas Austin examined exactly this issue: the relationship between CEOs and analysts. They surveyed a total of 4595 American analysts and examined the strategies and performance of the companies they made recommendations on.
In the surveys, they asked the analysts to what extent they had been given the privilege of personal access to certain top executives, in the form of private meetings, returned phone calls or conference calls, and so on. And how often this form of individual access was denied. They also asked them about personal favours that these CEOs might have done for them, such as putting them in contact with the manager of another company, recommending them for a position or giving advice on personal or career matters. Then Jim and Mike ran some numbers.
First of all, their statistical models showed that the CEOs of companies that had to announce relatively low corporate earnings started to significantly increase the number of favours they handed out to analysts, by granting them personal meetings, jovially returning their phone calls and making some much-appreciated introductions. Similarly, CEOs of companies that were about to engage in diversifying acquisitions – a rather controversial if not dubious strategy that the stock market invariably hates – engaged in much the same thing. Clearly, these CEOs were trying to sweet-talk the analysts and mellow the mood ahead of some rather disappointing announcements they were about to make. The question is: did it work…?
What do you think? Is the pope catholic? Is Steve Jobs whizzier than MacGyver? Did Neutron Jack eat all his meat?! Is Bill Clinton heterosexual…?!?! Sorry, let me not get carried away in analogy here, the answer is yes.
Of course it’s yes. It works. Analysts who received more personal favours from a CEO would rate a company’s stock more positively when he announced disappointing results or engaged in questionable strategies. And if they didn’t? Yep, you guessed it: those analysts who in spite of the favours had the indignity of downgrading the company’s stock all of a sudden ceased to see their phone calls returned, would be denied any further personal meetings and sure as hell were not given the phone number of the CEO’s golfing buddies. And the only remaining advice they ever received was to get a life and bend their bodies in ways that would enable self-fertilisation.
And this worked too. Not the self-fertilisation but the social punishment of the degrading analyst; other analysts aware of their colleagues' loss of status would be significantly influenced by their plight when making their own recommendations: they made sure not to follow them into the social abyss and were unlikely to downgrade the firm of such a CEO.
Thus, sweet-talking works. But mostly if followed by a good dose of old-fashioned bullying.