Analyst Compensation

We explore two questions here. If analysts are often wrong, why do they make so much money? Aren't they being rewarded for their stock-picking ability? For the most part, the answer to the first question may surprise you, and the answer to the last question is " sort of." Analysts are trying to help their brokerage firms or banks get trading commissions in the securities that they cover. That is, an analyst is hoping that his or her research will generate enough interest in a security that it will spur an investor to trade in it. This partially explains why so many analysts are trying to "sell" the stocks that they cover. As such, brokerage and investment bank analysts are commonly known as "sell-side" analysts, and they often appear like salespeople for the stocks that they cover. In a commentary that appeared in Money magazine, Blodget was even coined as a cheerleader for Amazon stock. [15] This need for analysts to root for the stocks that they cover may explain why Meeker was hesitant to downgrade Internet stocks even while the Internet bubble was bursting. Perhaps even more revealing is the fact that during the first part of 2002, only 2 percent of all stocks carried a "sell" recommendation [16] despite the unambiguous bearishness of the markets! Most savvy investors, however, know that a "neutral" or "hold" recommendation is a euphemism for getting the heck out of a stock, but this optimistic lingo used by analysts still promotes a bullish attitude. After all, not all investors are savvy.

Investors are not even obligated to transact in securities with the firm from which they obtained research. Large investors, especially , will simply search for the best execution prices regardless of the recommendation source. Shopping around for best execution prices is an outcome of the elimination of fixed commission fees back in 1975 ”previous to which time every brokerage firm was making large commissions off trades without having to compete in price. Without knowing how much analysts really contributed to commission revenue, how do they get compensated fairly for what they do? Indeed, quantifying an analyst's contribution to his or her firm's profits is difficult. One way around this may be to have analysts sell their research directly. Today, sell-side analysts' ratings and earnings estimates are widely and freely available, but this option may not be the most attractive one. The research reports that are the basis for those ratings and estimates still generally require a relationship with the analysts' brokerage or bank to obtain. Therefore, it is generally difficult to determine the fair compensation for analysts.

Given the difficulties associated with merit-based compensation for analysts, a significant portion of analyst compensation is now based on their reputations. For example, money managers and institutions participate in annual surveys, such as those conducted by Institutional Investor, asking them to rate and evaluate analysts along various dimensions. For each industry, analysts are ranked. A high ranking implies that the analyst is highly visible and is winning over customers. As such, he or she is likely to be well compensated. This form of compensation may encourage analysts to spend more time promoting themselves rather than working on their analyses. Henry J. Herrmann, chief investment officer at Waddell & Reed, claims that analysts get focused on saying what they think the client wants to hear in order to win the client. [17]

How much money do analysts make? The answer is a little tricky because it depends on whom the analysts work for. Senior analysts working for companies with no investment banking services earn an average of about $500,000 per year. The average rises to $1.5 million per year for senior analysts working for investment banks. [18] The top few analysts in the industry have earned closer to $10 or $20 million, depending on the particular year. Even relative rookies in the field often earn more than $100,000. Jack Grubman earned about $20 million per year. He left Salomon Brothers in August 2002 while he and the firm were under investigation from regulators. His severance package included forgiveness of a $19 million loan and $12 million in Citigroup stock. [19]

Why do analysts make so much money? Especially curious are those analysts working for investment banking firms who don't earn commission revenue. However, there is another way for analysts to get compensated. A part of their compensation has increasingly been dependent on the amount of investment banking business that they can bring in. For example, some star analysts have been getting 75 percent of their compensation from the investment banking side of the firm for which they work. [20] As such, equity research departments seem more like a support function for investment banking. In 2000, Grubman even boldly stated that, as a banking- intensive analyst, he represented the new model of analysts. [21] This trend bucks the traditional view of what analysts do for a living. This, in and of itself, may not seem so bad. However, this partnership between traditionally separate arms of an investment banking firm leads to a very serious conflict of interest problem.

Infectious Greed. Restoring Confidence in Americas Companies
Infectious Greed: Restoring Confidence in Americas Companies
ISBN: 0131406442
EAN: 2147483647
Year: 2003
Pages: 118 © 2008-2017.
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