For some time, there has been a sort of “grade inflation” going on in the recommendations of financial analysts says Bruce Bartlett, a senior fellow at the National Centre for Policy Analysis in the U.S.A.
There are several reasons for this trend. Most financial analysts work for investment banks that underwrite new share issues. Although they are supposed to be shielded from pressure to favour the shares of the investment bank’s clients, it cannot be eliminated.
Although analysts are seldom actually fired for making politically incorrect recommendations, they have long known that they can pay a price. Companies that they follow may cut them off and make it hard for them to get information about them. Their employers may give larger bonuses to analysts whose recommendations bring in underwriting business and demote those who anger potential clients.
This has created a bias within financial markets that helped hide Enron’s problems from investors. As a consequence, investors are often left thinking there is little difference between a share that simply will trail the index and one in danger of imminent collapse.
Arthur Andersen and other accounting companies have rightly been criticised for having conflicting interests when they both do a company’s books and have large consulting contracts with it as well.
Financial analysts have the same problem when their employers solicit underwriting business. The solution is the same in each case: total separation of functions.
Source: Bruce Bartlett, senior fellow, National Centre for Policy Analysis, March 6, 2002.
For text http://www.ncpa.org/edo/bb/2002/bb030602.html
For more on the Stock Market http://www.ncpa.org/iss/eco/
FMF Policy Bulletin\12 March 2002
