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Sell-side analysts' creation of value – key roles and relational
capital
Article in Journal of Human Resource Costing & Accounting · April 2007
DOI: 10.1108/14013380710746393
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JHRCA
11,1
Sell-side analysts’ creation of
value – key roles and
relational capital
30
Jeaneth Johansson
Department of Business Administration and Social Sciences,
Luleå University of Technology, Luleå, Sweden
Abstract
Purpose – The purpose of this paper is to increase the transparency of the value-creation chain in the
stock market. It aims to: conceptualize the value-added through the relational capital, inductively
develop models on how values are created, and discuss the values created for the analyst firm, the
clients and investors in the stock market in general.
Design/methodology/approach – The paper is based on a case study of sell-side analysts at a big
Swedish investment bank and their work with real life situations of changes in recommendations.
Findings – The findings of the case study indicate that analysts, through their relational capital,
access competitive advantages needed for remaining on a highly competitive market. They get access
to value-added information and knowledge and also business for the firm. This helps them to fulfill
the three roles played, i.e. as information intermediaries, knowledge builders and businessmen.
However, the analysts’ dependencies, due to their relational capital and the analysts’ conflicting roles,
result in ambiguous or even biased information. The values added to clients differ between prioritized
clients who receive value-added information through the relational capital with the analysts and
non-prioritized clients with limited, or no access, to the analysts’ services.
Originality/value – Value created through relational capital within organizations has been
intensively studied within the area of intellectual capital. However, the sell-side analysts’
value-creation chain linked to their relational capital with company representatives and clients,
considered in the present study, has been neglected.
Keywords Value chain, Stock markets, Investors, Banking, Sweden
Paper type Research paper
1. Introduction
This section starts by discussing the stock market. Sell-side analysts are identified as
key actors in this market and the analysts’ relations with company representatives
and clients seem to be a central part of the value-creation chain in the market.
Hence, the analysts’ relational capital is considered.
1.1 What is actually going on in the stock market?
What is actually going on in the stock market? How are values created?
Journal of Human Resource Costing &
Accounting
Vol. 11 No. 1, 2007
pp. 30-52
q Emerald Group Publishing Limited
1401-338X
DOI 10.1108/14013380710746393
The author is indebted to many people for the development of this paper; however, the author
take full and complete responsibility for content and presentation. Professor E. Häckner, at Luleå
University of Technology, provided numerous comments and much guidance on early drafts.
This study could not have been completed without the support of Handelsbanken, Jan
Wallander’s Foundation for Research. Additionally the author owes much to the research
participants who gave unselfishly of their time to support the research project.
“Knowledge has become the primary ingredient of what we make, do, buy and sell.”
Thus; “managing it – finding and growing intellectual capital, storing it, selling it, sharing it,
has become the most important economic task of individuals, businesses and nations”
(Stewart and Stewart, 1987).
The stock market is an arena where exchange of information, knowledge and financial
resources constantly takes place between individuals and organizations. Focus in this
paper is on values created by sell-side analysts[1] who are specialists on sectors and
companies and work for different kinds of financial institutions, such as investment
banks. The analysts provide independent analyses distributed through written and
verbal recommendations and services to their target clients, i.e. institutional
investors[2].
The analysts play an influential role in the stock market. Among accounting
researchers, they are seen as a reasonable surrogate for the investors’ expectations of
earnings in the market and a proxy for market uncertainty (Schipper, 1991; Stickel,
1995.) In a short time perspective, the analysts’ recommendations seem, to influence the
price of a stock (Givoloy and Lakonishok, 1984; Stickel, 1995), and, according to studies
on the market level, their written recommendations tend to convey valuable and new
information (Ho, 1995; Stickel, 1995; Womack, 1996). Prices also respond to analysts’
recommendation changes, and move up with upgrades and down with downgrades[3].
The responses and market adjustments tend to be spread over a longer period, starting
before publication of the recommendation and ending after the publication (Bercel,
1994; Stickel, 1995; Womack, 1996). Analysts tend to create values in the stock market.
Analysts are often seen as a key complement to a companies’ own disclosure of
information to present and potential investors in the stock market. Findings on
companies’ disclosure of information indicate that firms use direct contacts with
analysts as a source of voluntary disclosure of information, e.g. on intangibles
(Garcia-Meca, 2005). Traded companies disclose information through different
channels on a regular or irregular basis. Examples of formal channels of written,
one-way character are: company reports, press releases and company home pages.
For instance, the annual report is found to be of vital importance for information users,
even though it is not sufficient for fulfilling their needs (Vergoossen, 1993). Information
is also disclosed through verbal channels of a less open and more informal character,
such as direct contacts with investors and analysts. Direct contacts include two-way
communication and might involve one-to-one meetings, on-site visits, management
presentations, conference calls and phone calls. The analysts direct contacts with
company representatives is commonly rated as one of the most important information
source by the analysts (Arnold et al., 1984; Olbert, 1992). The analysts tend to play a
role in the disclosure of company information and direct contacts seem to be important
for fulfilling this role.
1.2 The analysts’ relational capital
As illustrated above, an analyst firms’ relationship with its closest environment can be
expected to influence the analysts’ work and the output of this work, e.g. in terms of the
analysts’ capability to understand, analyze and make decisions (De Castro et al., 2004)
Based on this argument, it is of interest to further consider the analysts’ relational
capital. The relational capital refers to the relationship an organization has with its
environment and the value of this relationship (Bueno, 1998). It also refers to the
Sell-side
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31
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32
external structure of the intellectual capital (Sveiby, 1997) and can be considered in
terms of customer capital (Edvinsson and Malone, 1997; Stewart and Stewart, 1987)
and supplier capital (Sveiby, 1997). Here, customer capital refers to the relational
capital between the analysts and their clients, hereafter “client relational capital”.
The supplier relational capital is mainly connected to company representatives
supplying information to the analysts. This relational capital is hereafter labeled
“company relational capital”.
Roos and Roos (1997), see the relational capital as a part of a company’s strategy for
obtaining competitive advantages. Relational capital is used in a strategic manner in
organizations to create and use knowledge to enhance firm value (Roos and Roos,
1997). As seen above, value created through relational capital within organizations has
been studied within the area of intellectual capital. However, not much is known about
the values created through the analysts’ relational capital. Holland and Johnsson
(2003), state the need to increase the understanding of how analysts’ relational capital
contributes to value-creation.
The present study does not aim to measure the relational capital in terms of
digits and sketches, or to consider the reporting of such measures in practice
(Mouritsen et al., 2001a; Brennan, 2001). Instead, relational capital activities by the
analysts, the company representatives, the analysts’ clients, and the analysts’ work
processes, are related to narratives of the values generated through the relational
capital (Mouritsen, 2000, 2004; Mouritsen et al., 2001b). The relational capital is
considered within organizational processes in which the capital is produced and
used (Holland, 2001). The values of relational capital are considered, both from the
internal investment bank perspective and from the external client and stock
market perspectives.
The main purpose of this paper is: to make what people say and how they act in the
stock market more transparent from an organizational and market perspective.
This paper is supposed to increase the transparency of the value-creation chain in the
stock market. This improved transparency is intended to facilitate the dialogue,
interpretation and reflection on the values created through the relational capital.
More specifically the study aims to:
.
conceptualize the value-added through the relational capital;
.
inductively develop models on how values are created; and
.
discuss the values created through the relational capital in terms of values for the
analyst firm, the clients and investors in the stock market in general.
Questions to be considered are:
.
Which values are added through the sell-side analysts’ relational capital?
.
How are values added through the relational capital?
To fulfill the aims and to explore the two research questions above the paper is
organized as follows. Section 2 includes a presentation of the research method. The
case study is introduced. It is based on sell-side analysts at a big Swedish investment
bank and their discussions of real life situations with changes in recommendations,
e.g. from buy to sell. In Section 3 empirical findings on the analysts’ “company
relational capital” are considered from the two questions:
(1) Which values are added to the analysts through the “company relational capital”?
(2) How are these values created?
Section 4 includes a presentation of empirical findings on the “client relational
capital”.Two questions regarding values provided to the clients are:
(1) What values are provided by the analysts to the clients?
(2) How are these values distributed to clients?
The question: which values are added to the analysts’ organization through the
“client relational capital” is also considered. Empirical findings on the relational
capital and dependency, caused by the two types of relational capital, are presented in
Section 5. The final section contains discussions and conclusions. The value-added
through the relational capital is conceptualized and two models are developed, i.e.:
(1) the model on investor’s relational capital because of the relations with analysts;
and
(2) the model on the relational capital loop.
The section ends with discussions of future research.
2. Research method
The case was designed as follows. Totally 20 sell-side analysts, working at a big
Swedish investment bank, participated in the study[4]. Each analyst discussed some
cases with changes in real life recommendations they had actively worked with[5].
Around 80 situations were discussed.
One main criterion for selection was access to sell-side analysts working at an
investment bank. The problems of access to analysts are well known. Analysts tend to
be reluctant to talk to researchers because of time pressures, personal hesitancy and for
reasons of confidentiality. For this reason, I spent a lot of time in building of my
relational capital in order to establish confidence and gain access. The research outline
was developed in accordance with a “Snowball” research design. This technique is
particularly helpful when approaching actors groups difficult to access and to
access information of a sensitive nature, such as the content of the analysts’
recommendations (Miles and Huberman, 1994). In the paper, the investment banks, the
traded companies and the persons interviewed are anonymous.
The present paper is based on extended face-to-face interviews. The first two
interviews, performed in 2000, served as a base for the development of the study.
The first analyst was interviewed on five occasions (12 hours), and the second analyst
was interviewed on four occasions (8 hours). The interviews with the remaining
analysts, performed in 2001, lasted between 15 minutes to two hours. Interviews were
tape recorded and hand written notes were taken as a backup. Transcribed interviews
were coded and patterns of responses were identified from the data. Findings were
then compared between the different cases, with changes in recommendations
discussed by each one of the analysts. Findings were also compared between the
analysts. The interviews were inductively analyzed and used for conceptualization and
development of inductive models (Glaser and Strauss, 1967). Case quotations are used
as illustrative examples of the empirical findings.
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3. Values through the “company relational capital”
Empirical findings on the “company relational capital” are now presented from the
perspective of the analysts’ value-creation chain and values created for the analysts.
Values added, through information and knowledge, are first presented. This is
followed by findings on financial values and how such values are created.
34
3.1 Values added through information and knowledge
Findings on values added through information and knowledge are now presented in
connection with the two questions, i.e.
(1) Which values are added?
(2) How are values added?
3.1.1 Which values are added? The findings indicate that the analysts’ see official
information as basic information, while information received through direct contacts is
seen as value-added information. The value-added information and knowledge, gained
through direct contacts with representatives, help the analysts to provide original
analyses and distinguish from other analysts. This information is frequently received
on a daily basis. It can be concluded that the verbal information received through direct
contacts adds value to the basic information of written character. This is exemplified
by the two quotations below:
The daily stream, more up-to-date information is always received directly from the company
in form of telephone contacts or personal meetings. That is what one used to call value-added
information. The other is only information for me to be on fairly the same level of knowledge
as my competitors. One should find the value-added information, the high qualitative
information, which is received through a direct conversation with them.
Personal sources in the companies, they are extremely important. You receive as much new
information from contacts, through phone calls, as you receive from written sources. I find it
really valuable to receive more information.
Direct contacts with company representatives provide value-added information and
knowledge. Different kinds of value-added information are identified below:
.
Information that helps analysts to validate and/or justify their own conclusions
is perceived as value-added information. Analysts often discuss and test their
own conclusions on company representatives. Company representatives tend to
be a support in the analysts’ decision process and in their argumentation in front
of clients. The three quotations below exemplify the analysts’ testing of
conclusions on company representatives:
Company representatives, when it comes to [company] did I test my conclusions and
hear what they said about it.
[Company], though much of my conclusions were based on what they might buy or not
buy, were the comments from the company very important.
Information from direct contacts in the company were fairly important in [company], we
talked with people who confirmed that it was really troublesome, in the short-term.
.
The analysts’ work is to prognosticate a company’s future. The history is well
known, while the future is uncertain. Available information is limited.
Value-added information, e.g. on the companies’ own plans and expectations,
helps the analysts to deal with the uncertain future. The quotation below
illustrates how analysts can verify information on the future:
Though we built this case on the future, on what we thought would occur in the future, it
was necessary to have a lot of contacts with the company to see what on earth they had
in the pipeline. Such information is really difficult to verify somewhere else since nobody
else knows about it. It is a secret . . . or secret, nobody else has this knowledge.
.
Unique companies, without industries, competitors or clients to compare with,
imply high uncertainty and scarce information for the analysts. This is also the
case with small companies where the disclosure of information is limited.
The analysts receive value-added information to deal with such uncertainties.
The first quotation below illustrates value-added information connected to
unique companies, and the second connected to small companies:
When companies are unique, where there are no industries, there are no real competitors,
and then it is difficult to find objective information. Subjective information from the
companies is often received, you receive the management’s opinions but you have to be
critical to that . . .
In this case they were more active than normally since they were really interested in the
case. Though, small companies do not have much to disclose regularly, they have smaller
events . . . They consider it, when an analyst after all arrives and looks at our little
company . . . then they become happy and “pop up” and then you receive information.
.
Complex companies, for example, companies with many lines of business, are
difficult to understand for the analysts. Representatives familiar with the
companies make them more comprehensive by providing value-added
information. This is illustrated below:
In this case they were even better [than usual] to help me since they really wanted me to
understand the company so they became more active . . . and [they] came with initiatives
to present the company. It is so complex; though it is so complex, they tried to give me a
fair view of it.
.
Publicly disclosed information tends to be of an ambiguous nature. Standardized
information is limited in character. Analysts receive value-added information
which complements the publicly disclosed information and makes it less
ambiguous:
In the case with [company] I did talk pretty much with the company management since the
press release was not clear in the interpretation of the agreement for their co-operation.
.
Analysts receive value-added information adjusted to their needs in specific
situations from direct contacts with representatives. For instance, questions posed
by analysts are answered through direct contacts. In event-driven situations, the
Sell-side
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analysts require fast up-dating of the situation, and such value-added information
is often received from direct contacts with company representatives:
However, that kind of information source is generally more high qualitative for the
particular case. One often builds cases on particular questions and these questions can
often be answered through personal contacts.
36
When such things pop up [refer to a particular situation], then [the sources used] are:
phone, personal meetings and competitors. When one talks with these three, it is where
the up-to-date information is found.
.
The analysts receive information and knowledge of tacit and intuitive character.
Subtle information on top-management is received by analysts when they know
the management and also have a track-record of earlier situations. Knowledge
about how company representatives think adds value by making what they say
and their actions more transparent. How value-added information of tacit
character is received exemplified through the quotations below:
Confidence in information from personal sources . . . In the [company] relatively low
[confidence] since I mainly discuss with the CEO, he is always optimistic.
Direct contacts, they are always valuable, then it depends on how well you know them
[the representatives], but it is always, you can discuss and receive, not only direct
information though one can experience feelings and such things, then you know that
they occasionally say too much.
Then one should know that when they [the representatives] are negative they use to
utilize less negative words for instance, “maybe we ought to be a little better in this
business area”. This is often the reason why they don’t perform well. So when they say
that something is positive, keep an eye on it. When they say that something is negative
then you really wonder what is this.
Especially, [company] knows exactly what they are allowed to tell and what they cannot
tell and (they) are very restrictive with their information. Though, one can better
understand how they think by talking with them.
.
Value-added information is adjusted to the analysts’ needs, and helps the
analysts to deal with the problem of receiving timely and relevant information.
Value-added information is information that helps the analysts to distinguish
relevant information from irrelevant information. It helps the analysts to deal
with the problem of information overload. Analysts build up competitive
knowledge through the value-added information from the companies in order to
be able to draw novel conclusions and distinguish themselves from other
analysts. The quotation below illustrates the access to timely and relevant
information:
There is so much information today, it comes faster and it is available for more people.
This makes it more difficult to find something that is new. It becomes even more
important to have a good contact with the company one follows. Though so much is
written, it is distributed so incredibly much on internet and one can obtain analyses from
other firms on the internet. So the information is really a fresh creation that becomes sour
after only a couple of minutes. So a tight relation with the company is really important
because, even though one does not receive any new information, you can always by
knowing the company well, draw better conclusions on what one gets to know. Since, it is
not the one who has the most information it is the one who can use the information
smartest and has so much associated knowledge that one can draw the right conclusions,
that’s the winning analyst.
Sell-side
analysts’
creation of value
This quotation indicates that the analysts’ relation to representatives is central for their
access to value-added information. The relation is further discussed below.
3.1.2 How are values added? To understand the content of the value-added
information, it is central to understand how values are added to the analysts’ work.
Analysts tend to have a responsibility to build up relational capital and to access
value-added information through direct contacts. According to the analysts, their relations
with clients are, crucial for accessing value-added information. Better contacts imply
closer relations. The closer the relation the better is the likelihood of accessing high
qualitative, relevant, timely information adjusted to the analysts’ needs. Information is
also received faster when the relation is close. Relations with many representatives are
valuable in order to access the value-added information. The quotations below illustrate
how relations influence the analysts’ access to value-added information:
37
Though, it is a little like . . . our work is built on receiving personal contacts. The better the
contacts are with the companies, the easier and the higher is the likelihood to access
information easily.
We wanted to build up as personal contacts as possible to feel that we always can access
information and receive it fast. It is not that we want information that nobody else has to get
into an insider situation. Neither we, nor the company, want that . . . But to build up personal
contacts, to easily access information . . . then, it is easy to call. If you have a good relation
with someone . . . if they aren’t there and you leave a message then the probability is higher
that you get a fast call back. Then you benefit from receiving the information fast, you do not
need to wait two days.
You have to have a well established network, and you have to talk with people, so our work is
a little to get through the gatekeeper as the IR [Investor relation person] are, and build up a
network, and understand some differences in nuances.
It really differs between companies in how information is intermediated and how easy it is to
access information and the degree of personal contact. Like in [company] . . . it is “Hey there”.
We are not friends, but, it is a really good contact, it is! You can call them whenever you want
and they return the call as fast as they can. It is tougher in other companies.
The analysts own experiences of asking intricate questions influence the information
received. The quotation below illustrates how analysts by posing questions on the
official history, receive information on the future that may not be as official:
However, after a while as an analyst, you learn how to ask questions in a way that you, can
interpret where the management actually takes off. If you ask management about what their
earnings will be, you do not receive an answer. But if you ask management; “The story you
told us a quarter ago, are you still comfortable with that today?” Then you relate to what he
has told about the future . . . If he says that he still is comfortable with the situation, then you
understand that he still feels comfortable about how the company is developing. But, if you
ask like this; are you comfortable? He says yes, but you do not obtain anything from it, one
thinks ok. . .
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3.2 Values added through the generation of business
Analysts’ generating of business for the firm is also a value-added through the
“company relational capital”. Companies are not only potential investment objects for
investors, but they are also potential corporate business for the investment bank
and the analysts are supposed to identify such potential businesses. Values added refer
to the analysts’ access to businesses, i.e. financial values for the firm:
It works like . . . we have different kinds of co-operations: the analysts are expected to come
with ideas around potential corporate finance businesses. You meet your companies, and then
you might catch that the company possibly will sell a particular part. . . . then you are
expected to provide the information to the corporate finance [department]. Nevertheless, the
analysts are not supposed to know what corporate finance does with the information in
publicly listed companies. They may well start a project, but the analysts are not supposed to
know [about it], since the analyst [then] becomes an insider.
It can be concluded that analysts play an indirect role as businessmen toward the
companies. Their suppliers of information and knowledge are also their clients. It can
also be concluded that the relational capital connected to the analysts’ direct contacts,
is a central part in the analysts’ value-creation chain because of its possibilities to gain
access to value-added information, produce new knowledge and identify businesses for
the investment bank.
4. Values through the client relational capital
Value-added information and knowledge from direct contacts with company
representatives are processed together with the analysts’ previous experiences and
information from other sources. Analyses are provided to clients through
recommendations and through verbal discussions. Written recommendations are
considered within their wider context, i.e. as one part of the analysts’ services to clients,
for a better understanding of the value-creation chain. To begin with, values provided
by analysts to the clients are discussed. Values for the analysts and their organization,
through the “client relational capital” are then presented.
4.1 Values provided to clients
The analysts’ value-creation chain, connected to the “client relational capital” is further
identified. Two questions are considered from the analysts’ perspective. First, which
values are provided to the clients? Second, how are such values provided to clients?
4.1.1 Which values are provided to clients? Analysts provide their clients with
services through written recommendations and personal contacts. According to the
analysts, information received through the written, publicly available,
recommendations tends to be of basic value for their clients, while verbal discussions
of private nature tend to be of a value-added character. The quotation below illustrates
the basic service provided through written information, and the value-added service
serving as a complement. Analysts summarize their main conclusions in front of clients
and comment on how they reached these conclusions. Personal contacts add value by
providing the clients with up-dated information on central aspects:
The structure is like; we work a lot towards the clients. The writing of analyses is only a
small part of it. It is to serve clients, partly with conclusions from the analyses, but also much
more. The [aim of the] recommendations is to build a speakers’ corner for the institutions on
the companies followed, this to be able to continuously provide clients with service on
important events in the company, important events in the sector, important trends.
Information needed and provided to different types of investors varies. Information on
company-specific character and the analysts’ opinion of such information is
value-added information for the clients, according to the analysts.
I would like to say like this, what is important for me as an analyst, that is actually not what
this company is worth or what recommendation I have on the company. That is uninteresting
for our clients. They want to know, do we find the company well managed? Do they [the
company] have the right strategies? What can be improved [in the company]?
Private investors typically need clear recommendations of, e.g. buy or sell, according to
analysts. Such information is mainly of a basic and static character. Clients get
value-added information through verbal discussions, flexible in character and adjusted
to their needs. The quotation below illustrates how the needs by the analysts’ clients
and small investors vary:
One can say that our institutional clients do not care about what recommendation you have.
That is not what they want. However, the smaller clients, the private clients need advice on
what to do with a share. Big institutions, want a dialogue on the company, the sector, trends,
developments . . . and then they make their own decisions. They do not care if we say buy or
sell. One can say that the picture on the recommendations is divided though they are
important for small clients, but completely unimportant for big [investors] or at least of very,
very small relevance [for investors].
Through the personal contacts, clients want, to know what the company management
says. This indicates that analysts play a role as information intermediaries. Clients also
want this information further analyzed and interpreted by the analysts. This indicates
that analysts play a role as knowledge builders. The above quotation illustrates that
analysts supply clients with both financial information and non-financial information.
Non-financial information, for instance, supports the analysts’ conclusions on their
estimated prognoses. According to the analysts, knowledge about the analysts work
processes helps, the client to understand their way of thinking. The quotation below
illustrates the clients’ needs:
What do the companies say . . . the company management? What does your prognoses look
like? What are your assumptions on your prognoses? I suggest a Buy . . . Then they say: I do
not care. They [clients] want to know how you look at your estimates, how you look at the
companies and what is going on around the world. Then they look at the share.
Analysts’ primary clients, i.e. institutional investors, want information and knowledge
that add value to their own, already informed, decision process. Information
supporting clients in their decision process is value-added information. This is
exemplified below:
They [investors] want knowledge on the company, and then they state their own strategies
for shares.
Detailed and in-depth information and knowledge produced by analysts as specialists
is of value-added character for the generalists who, themselves, produce less in-depth
analyses. Opinions by analysts also add value to the clients. The quotation below
exemplifies how specialists can add value to generalists:
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40
Fund managers are generally not as detailed [as we are]. I have three companies, but the
clients may have 10, 20 or 30 companies that they follow. When something happens in a
company then they call around. Then they weight it together. It sounds reasonable, it
sounds good, it will probably occur, and then they may buy on that information. This
makes it very important for us as analysts to be ready to have an opinion. The fund
managers do not buy only at one firm, they form an opinion based on many information
sources.
Which values are then provided to clients? It can be concluded that analysts provide
clients with value-added information and knowledge, supporting the client in his/her own
informed decision process. The roles played by analysts illustrate the values provided.
The analysts’ role as information intermediaries refers to providing clients with
value-added company information, received through direct contacts with company
representatives. The analysts’ role as knowledge builders refers to the analyses they have
performed and that ends in conclusions and a base for their opinions.
4.1.2 How are values provided to clients? When analysts’ provide their written
recommendations this typically takes place at the same time to all clients. This
information, of a static character, is complemented with additional information and
knowledge intermediated and developed through verbal discussions with clients.
According to the analysts, such discussions are flexible in nature. The personal sources
are of a more or less open character. For instance, phone calls and one-to-one meetings
are of exclusive character, while meetings with many clients are more open in
character. Private meetings in which the client privately can discuss with the analysts
tend to be particularly value-adding for the clients. The complemented information and
knowledge is, successively distributed to clients in a prioritized order. The quotations
below illustrate how basic information is provided to all clients at the same time and
how value-added information is successively provided to clients:
The marketing of the change was . . . we have the same routines in this firm when writing a
change in a recommendation. We discuss it in the morning meeting and then we distribute the
information. If you have personal clients . . . even the analysts have today contacts with
clients . . . you call them [the clients]. However, you make a presentation in the morning
meeting for the analysts and the brokers so they can retell the story . . . to their clients
afterwards.
Generally, everything is distributed through e-mail to all clients, and then you call those
prioritized and talk with them.
The scope of the marketing of a recommendation varies between different situations
and this can also be expected to influence the information received, e.g. by clients and
non-clients. A broad marketing effort can be expected to reach more investors than a
narrow marketing effort. The quotation below illustrates such a case:
The marketing of the change . . . it was really broad. It was everything, it was phone calls, it
was meetings, it was sales and it was PowerPoint presentations, [we] also took the clients to
the companies, arranged client meetings with many clients where they directly could ask the
company questions.
Based on the findings above, it can be concluded that the analysts’ relations with
company representatives provide the analysts with value-added information that is
either intermediated to clients or further processed before it is provided to clients.
The value-added information and knowledge is then used by clients in their own
decision processes. Some clients are more prioritized than others. It can be concluded
that the values provided to clients vary between clients because:
.
value-added information and knowledge is successively distributed to prioritized
clients; and
.
the distribution of value-added information takes place through exclusive
personal contacts.
It can also be concluded that the clients’ relations to the analysts influence their access to
value-added information and knowledge. Prioritized clients can access a higher degree
of information and knowledge than non prioritized clients because of their better access
to personal contacts with analysts. Prioritized clients can also access information and
knowledge faster than non-prioritized clients because of their better access to analysts.
Based on the discussion in part one in this section, small private investors, the indirect
clients, do not access the value-added information and knowledge from personal
contacts with the analysts who produce the recommendations.
4.2 Values added for analysts
According to findings above, analysts provide many different values to clients through
their personal contacts with the clients. In order to understand the analysts’
value-creation chain, is it of importance to know: “which values are added to the
analysts’ organization through the “client relational capital”.
Analysts play a role in their firm acting as salesmen and generating trading
business for the firm. Written recommendations serve as a basic concept sold to all
clients. Personal contacts are used to convince clients to act in accordance with the
recommendations. However, analysts adjust to the situation they are faced when
meeting clients. Shares other than the ones discussed, are suggested as potential
trading business. A quotation by an analyst describing the selling process is illustrated
below:
You decide for an opinion and then you write in accordance with that and the noted price,
then you go out and sell the case, our analysts are our salesmen. To a great extent, it is when
you sell it you convince and if you succeed to convince the investor then they [the institution]
buy the share. Otherwise, you get an interesting dialogue and then he [the portfolio manager]
finds that you have an interesting case, but do not agree, then you consider if he wants to buy
any other share or if he sells the share discussed.
The analysts’ clients indirectly pay for the analysts’ services through the commission
generated when trading. This is illustrated below:
They pay through commission, they pay for our service.
The analysts act as salesmen, both in Sweden and abroad. International clients are also
provided with written recommendations of a basic character and value-added
information through personal meetings. One analyst exemplifies how he worked in a
particular situation:
It is distributed to sales in all offices abroad. I discussed with clients, had many client
meetings in this case, both in Sweden and abroad.
Sell-side
analysts’
creation of value
41
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42
As seen in Section 4.1 a main part of the marketing of the analysts’ recommendations
and services to clients is done through personal contacts with clients, for example,
through phone calls and meetings. The analysts, in their work, want to tie the clients’
organization to their own organization by satisfying their needs, both on the
organizational and the individual level. The selective and exclusive distribution of
value-added information and knowledge to prioritized clients[6] may be an expression
of how analysts tie clients to their own organization. The quotation below illustrates
how clients perform business with firms and what analysts consider as important for
gaining access to businesses:
The clients do not have accounts in our firm; [i.e.] the big institutional clients are free to make
their businesses wherever they want. Typically, they spread out their businesses on a
“handful” big suppliers and we are one of these. They want to do business with several firms
to receive information from several firms. But there are no agreements or such contracts, it is
really like, everyday is a new day in that sense. The way to get clients to make a lot of
business with us is to have good analyses, a high level of service, both from our analysts and
brokers. It is really important to know the client very well and know how the client is
organized, what needs every individual at the particular institution has.
According to analysts, personal contacts with clients are important in order to
understand and to be able to take care of the clients’ needs, and also to tie the clients
to their own organization. Personal contacts are important for analysts when they want
to develop close relations with clients and a lot of time is also spent on such contacts, as
illustrated below:
[We spend] as much time with the clients as possible.
A change in the clients’ structure of doing businesses increases the importance of the
“client relational capital” for gaining access to businesses. The environment has
become more competitive. It is important for the analyst firm to be among the few
selected actors which the clients’ institutions trade with. The change in the analysts’
environment is illustrated below:
The clients concentrate their business on fewer and fewer suppliers. . . . earlier they spread
out their businesses on one tenth [of all broker firms] now it is three [firms] that receive the
main part of it [business]. It is a trend one sees.
The competition is intense among sell-side analyst firms and clients constantly
evaluate the service provided. The size of the analyst organization tends to influence
what category of player the analysts need to belong to. A large organization tends to be
dependent on being among the few selected analysts who provide clients with the main
part of their business[7]:
The clients constantly evaluate us, annually or more frequently . . . they tell us what category
of suppliers we belong to, if we are top-three or if we are in fourth, fifth place, or where we are.
It is our goal to be among the top three ranking and that is important since most clients
distribute 60-70% of their commission on the three biggest suppliers. Then it may be six to
eight players that have to fight for the remaining part. That is a too small a share for us with
such a big analysis department that we have.
Based on the findings above, it can be concluded that relational capital is central for the
analysts’ role as businessmen for their own organization, generating commission for
the firm. It is a highly competitive environment and gaining access to clients is vital for
the firm. The relational capital adds value when analysts’ manage to tie clients to their
firm. It also helps the analysts to identify and fulfill the clients’ needs. Finally, the
relational capital adds value by improving the analysts’ possibilities to succeed
(survive) in a highly competitive market:
“Client relational capital” seems to be vital when analysts want to make business for the
investment bank.
5. Relational capital and dependency
Based on the findings in Sections 3 and 4, it can be concluded that analysts’ relational
capital is vital for the analyst firm’s survival in a highly competitive market. Relational
capital adds value to the analysts through the generation of information, knowledge
and businesses. It also adds value to clients through the generation of information,
knowledge and probably also financial benefits. The values added help the analysts to
fulfill their three key roles, i.e. as:
(1) intermediaries of company information;
(2) knowledge-builders; and
(3) businessmen for the investment bank organization.
However, the vital importance of the relational capital implies a high dependency by
the analysts on company representatives and clients in order to gain access to the
competitive advantages needed. The different dependencies in the value-creation chain
can be illustrated through four steps. There is:
(1) a high dependency on company representatives in order to;
(2) gain access to value-added information and knowledge needed;
(3) to provide clients with value-added information requested; and
(4) to be able to generate trading business for the firm.
The analysts’ dependency on the clients refers to their access to clients’ trading
business. There is also a dependency on representatives in order to identify corporate
finance business that may become profitable for the investment bank.
The analysts’ dependencies on company representatives tend to influence the
content of the information in the analysts’ written recommendations as well as in
verbal discussions with clients. The analysts do not want to irritate the company
representatives and clients, so as not to harm the relation and to ascertain the
value-added information. They tended to disclose negative information in front of
clients through verbal sources, rather than through written sources, and they often
checked their own conclusions with company management before the disclosure.
In front of clients, when a client had recently bought a particular share, the
analysts hesitated to argue for a sell, so as not to question her/his authority. It can
be concluded that dependencies are a source of bias regarding the content of the
analysts’ recommendations and services. Verbal discussions added a value as they
diminished ambiguities regarding relational capital. Information disclosed verbally
was more subtle in character, adjusted to the particular situation and was in a
limited disclosed way, through the exclusive sources. This way, analysts could
Sell-side
analysts’
creation of value
43
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44
handle the conflicting roles of providing value-added information and knowledge
of relevant and honest character and still generate business for the firm.
Two interesting and contradicting findings worth noticing are that;
(1) The relational capital increases the ambiguity of information and knowledge
disclosed by analysts to clients.
(2) The relational capital adds value to the clients by decreasing the ambiguities
regarding dependencies, since the problem of ambiguity is dealt with through
personal contacts with clients.
I will return to these contradictions in Section 6.2.
6. Summary, discussions and conclusions
This section includes further analyses, a summary, discussion and conclusions of the
empirical findings in the preceding sections. To begin with, the two research questions
are posed and discussed, followed by suggestions for further research. The section
ends with some concluding remarks.
6.1 Which values are added through the sell-side analysts’ relational capital?
The values added by the analysts through “company relational capital” and “client
relational capital” refer to the receiving of value-added information and knowledge,
and the generation of business for the firm. “Company relational capital” refers to the
analysts’ gaining access to value-added information and knowledge to be used in their
informed investment decision process. The analysts’ need for value-added information
agrees with findings in a study by Previts et al. (1994). They found that contemporary
financial reports form an important, but incomplete, base for sell-side analysts’
forecasts for company performance. In different studies, direct contacts have often
been rated as one of the analysts’ most important information source (Olbert, 1992).
Studies of analysts’ clients also indicate that their personal contacts with analysts are
important for their work (Holland, 2006). This supports the central importance of the
relational capital, generated between key actors in the stock market.
Relational capital tends to be a key competitive advantage, needed by analysts to
remain in a highly competitive market. Relational capital generates competitive
advantages in the form of value-added information and knowledge, possibilities for
analysts and firms to be among the top-ranked ones, and makes the analyst firms
profitable and long-term surviving organizations This is in line with Holland (2006)
(Roos and Roos, 1997).
The concept of value-added information needs to be further developed in order to
understand the values created through relational capital. The concept of value-added
information seems to be fairly the same for both analysts and their clients. Use of the
value-added information and knowledge helps to further conceptualize the values
created. Value-added information is used for:
.
validating and/or justifying own conclusions;
.
dealing with uncertain situations;
.
dealing with uncertainty in companies/industries;
.
dealing with ambiguous information; and
.
dealing with problems of information overflow.
Characteristics of the value-added information also allow for further conceptualization
of values of the relational capital. Value-added information is:
.
timely;
.
adjusted to the users’ need for information and knowledge;
.
situation specific;
.
of both tacit and explicit character;
.
exclusive in character; and
.
includes novelty.
Sell-side
analysts’
creation of value
45
The conceptualization of value-added information above provides an insight into
information voluntarily disclosed by companies to financial analysts. The present
study contributes with a further understanding of values generated through relational
capital and expressed, e.g. through direct contacts. Earlier studies found that direct
contacts give financial analysts an opportunity to obtain timely and relevant
information about qualitative factors. In many studies; direct contacts are found to be
the most important information source used by analysts (Arnold et al., 1984; Olbert,
1992; Johansson, 1998). A summary on the relational capital according to central
dimensions is presented in Table I.
6.2 How are values added through relational capital?
It is also of interest to note that the content, the quality and the timeliness in
the value-added information, received from relational capital, is related to the
Central dimensions on analysts’ relational capital
Types of relational capital
Values added through the relational capital
Usage of value added information and knowledge
Characteristics of value added information and
knowledge
Outcomes from the relational capital
Company relational capital
Client relational capital
Value added information and knowledge
Trading businesses for the investment bank
Other types of businesses for the investment
bank
Validating and justifying own conclusions
Dealing with uncertain situations
Dealing with ambiguous information
Dealing with problems of information overflow
Building of relations
Timely
Adjusted to the users need for information and
knowledge
Situation specific
Of both tacit and explicit character
Exclusive in character
Includes novelty
Competitive advantages
Top ratings
Profitability
Long-term survival
Table I.
Relational capital
according to central
dimensions
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characteristics of the relation. This also tends to be the case with the degree of business
generated. Relations are here considered in terms of:
.
closeness (close relation to no relation); and
.
dependencies because of the relations (high dependency and low dependency).
46
A model on the investors’ relational capital and their relations is first developed.
Following this, a model on the relational capital loop, connected to dependencies, is
developed.
6.2.1 The model on investors’ relational capital. Close relations imply high access to
personal contacts with the analysts, while the most distant relations imply no access to
these contacts. Close relations and high access result in a high value-added through
the relational capital. Distant relations, or no relations, result in low or no access to the
value-added information. Institutional clients are the ones who gain access to the
relational capital, while the main part of the private clients does not[8]. Prioritized
clients receive a higher degree of value-added through the relational capital, than the
less prioritized clients. I propose that the typical combination of closeness in relations
and the value-added through the relational capital differs, based upon the type of
investor and that these positions can be plotted on a 3D graph with prioritizing of
investors, closeness in relations and degree of value-added through the relational
capital, as the axes. See Figure 1.
The proposition above is in line with the findings by Holland (2006), on the
organizational level. Sell-side analysts’ recommendations and other services were
considered to be of limited value for the fund manager, unless it was available to them
on a confidential basis, before it was published or released to other clients. These
findings may be interpreted as if the clients preferred to be among the prioritized
clients, receiving a high degree of value-added information through exclusive personal
contacts with the analysts, i.e. close relations.
Relation
Close
Prioritized clients
Less prioritized
clients
Private Investors – nonclients
No
relation
Figure 1.
Investors relational capital
High
Degree of value-added
through the relational
capital
Low
The analysts’ selective providing of value-added information to prioritized clients may
help to explain earlier findings on the market level. A time lag for price adjustments to
the analysts’ revisions in earnings expectations has been identified (Green, 2006,
Bercel, 1994; Stickel, 1995; Womack, 1996). Green (2006) also suggests that the time lag
may be due to the time when selected clients receive information, to the time delay of
interpreting and acting by others. This indicates that analysts’ add value to the clients
by increasing their possibilities to increase their financial values. It can be concluded
that the degree of values added through relational capital may be related to
information, knowledge and business.
6.2.2 The model on the relational capital loop. According to findings in the present
study, analysts have three key complementing and contradicting roles as:
(1) information intermediaries;
(2) knowledge builders; and
(3) businessmen.
The three roles are based on the relational capital with both company representatives
and clients. Values are added, but the analysts’ dependencies make information and
knowledge ambiguous. Analysts’ roles have received attention in earlier studies. In a
study by Williams et al. (1996), buy-side analysts perceived information from their own
direct contacts with company representatives as less important than opinions by
sell-side analysts. This supports their roles as information intermediates and
knowledge builders. Clients receive information voluntarily disclosed by companies to
analysts, and this information is further analyzed by the analysts.
Bricker et al. (1995) found that analysts’ reports in some cases, were mere
transcriptions of management presentations. This indicates that companies’ voluntary
disclosure, through direct contacts, is intermediated to investors. However, it also
questions the analysts’ role as independent knowledge builders, providing value-added
information for the companies’ own disclosure. The fact that company representatives
are both suppliers of information and knowledge, as well as potential clients for
corporate finance business implies that this type of relational capital refers both to
the client capital (Edvinsson and Malone, 1997; Stewart and Stewart, 1987) and the
supplier capital (Sveiby, 1997). Multiple values are generated through the same
relations and this indicates a particularly high dependence on the representatives, and
increases the risk for ambiguous information.
Besides, analysts’ responsibility to identify corporate finance business, they are also
salesmen who are supposed to generate trading businesses. Clients pay for the
analysts’ services, by paying a commission to the firm. The analysts’ role as
businessmen has also received attention in earlier studies (Holmes and Sugden, 1991;
Holland, 2006). Proimos (2005) identified conflicts of interest at an Australian
investment bank. In a study by Holland (2001), fund managers perceive that the
analysts were selling agents for corporate finance and an arm of the larger investment
banking business. This made the analysts’ information and knowledge ambiguous.
The analysts’ transcriptions of management presentations found in analyst reports
may be an expression of the dependency, causing ambiguous information in the
reports. Additional expressions for the dependencies identified in the present study
and in earlier studies are that analysts hesitate to reveal negative information on the
companies, since this may damage the relationship with company representatives and,
Sell-side
analysts’
creation of value
47
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48
thus decrease access to company information (Holland, 2001; Johansson, 1998). In line
with the discussion above; Sedor (2002), found that analysts unintentionally issued
optimistic forecasts on losses when information on managers’ plans were received in
form of scenarios. A study by Jackson (2005) also indicates that optimistic analysts
generate more trade for the firm.
However, both this study and earlier studies indicate that analysts’ clients are aware
of biases in the recommendations (Holland, 2006). Portfolio managers, for instance,
tend to rely more on information received from their own buy-side analysts than from
sell-side analysts (Cheng et al., 2006). In this study, analysts’ verbal discussions with
clients were used by the analysts to deal with the dependency related to the relational
capital. Clients received value-added information that also provided a better
understanding of the information content and quality in the written recommendations.
Contradicting findings how that relational capital both increases the ambiguity of
information and knowledge, due to the analysts’ dependence on key actors, while at the
same time, it diminishes this ambiguity is of interest. Relational capital adds value to
both clients and analysts, while dependencies decrease the value for the clients and,
thus, also for the analysts. Hence, analysts and clients deal with dependencies through
relational capital. This increases the value for both parts. I propose a model on the
relational capital loop in which positive values become negative, and negative values
become positive, based on values added from relational capital. See Figure 2. Findings
on ambiguous information because of dependencies can be interpreted in terms of
bounded rationality (Cyert and March, 1963; March and Simon, 1958).
6.3 Suggestions for future research
More needs to be known about analysts’ value-creation chain, and what kind of values
that are added through the analysts’ relational capital and how these values are added.
Three areas are suggested for future research.
First, further work is suggested on the conceptualization of the values added. For
instance, it is of interest to know how the values added differ between analysts and firms.
In a study by Holland (2001), on fund managers, only a selected group of analysts
demonstrated special skills in company and industry specific analyses, i.e. added value
to their investment decisions. Further studies on relational capital generated, as a result
Relational capital generates valueadded information and knowledge –
positive values
1
2
Figure 2.
The relational capital loop
Ambiguities are
3
dealt with through
the relational capital –
positive values
Dependencies
generate ambiguous
information and
knowledge –
negative values
of the analysts’ skills and the firms’ reputation would be of interest in order to improve
the understanding of the value-creation chain in the stock market.
Second, further development of the model on investors’ relational capital is
suggested to get a better understanding of how values are added. This could be done
through studies on different groups of investors, i.e. direct (institutional investors) and
indirect clients (private investors), and groups in-between the prioritized and
non-prioritized clients.
Third, further studies on the analysts’ dependency, due to the relational capital, are
suggested to increase the knowledge of how values are added. The model on the
relational capital loop need to be further tested and developed. One suggestion is to
further study the dependencies and ambiguities caused by the relational capital and
how this is dealt with when receiving the benefits from the values added through
relational capital. This could be made through a survey of analysts, companies and
clients.
The present study is performed during 2000 and 2001, in time with a deep recession
in the stock-market. The confidence in the financial sector declined and many of the
analyst’s employer organizations were slimmed to fit into the new situation. Some
years have past and the market has now stabilized. According to a recent discussion
with an analyst, the analysts’ value creation chain has not changed much. The
“company relational capital” and the “client relational capital” are still vital parts in
this chain. However, it would be of interest to further test the findings and the two
models developed in the present study in new contexts and by this continue the
conceptualization of values added through relational capital.
6.4 Concluding remarks
Companies do not disclose written official information and hope for the best. Getting
institutional investors and analysts to understand and to convince them, companies
voluntarily disclose additional value-added information through direct contacts with
their company representatives. Pretty much the same takes place regarding the
sell-side analysts’ disclosure of written recommendations to clients. The deeper
understanding and the convincing part, where analysts sell the recommendation, take
place mainly through verbal discussions with clients. Written information of public
character is limited and ambiguous in nature, and the relational capital tends to be vital
for receiving value-added information.
Companies tend to use analysts for disclosure of voluntary information to the stock
market. Analysts intermediate this information and/or analyze it further in front of
clients. It can be concluded that analysts complement the companies’ own disclosure of
information and, thus, help to increase knowledge about companies and reduce
uncertainties in company information. Analysts’ receive value-added information
needed, such as information on intellectual capital, through direct contacts with
company representatives. This may help to explain a limited interest by analysts in
mandatory regulation of disclosure on intellectual capital.
Objective and independent information tend to be difficult to receive from analysts,
because of the conflicting roles played by the analysts and their dependency, related to
the relational capital connected to both companies and clients. Clients tend to deal with
the ambiguity through personal contacts with the analysts, even though only a small
part of the investors have access to such contacts. They do not access values added
Sell-side
analysts’
creation of value
49
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50
through the relational capital with analysts. It is important to remember that analysts’
recommendations and services, provided to investors, have an impact on price levels,
issue discounts, bid-offer margins, volatility, and liquidity of stock prices. Based on
this, the analysts’ recommendations should only be seen as one complement to
companies own disclosure of information. A suggestion to companies might be to
develop interactive annual and interim reports, where information is constantly
up-dated and adjusted to the users’ needs.
Notes
1. Hereafter, the analysts, if nothing else is written.
2. Institutional investors represented by fund managers and buy-side analysts. Buy-side
analysts are generalists and they prepare similar recommendations as the sell-side analysts
but for internal use (Cheng et al., 2006).
3. Though there tends to be a higher response to downgrades than to upgrades (Ho and Harris,
2000).
4. All sell-side analysts except one, who declined to participate due to lack of time.
5. In the present study, the written recommendations refer to a written report where the
analysts state a change of opinion, e.g. from “Buy” to “Sell”. The recommendations contain
around 10-30 pages of financial and non-financial information, in which the analysts argue
for the recommendation.
6. See Section 4.1
7. The dependency, and the consequences of dependencies, is further discussed in Section 5.
8. There are probably prioritized private clients with access to the relational capital, who
benefit from the value-added information received through personal contacts with analysts.
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management”, Journal of Intellectual Capital, Vol. 1 No. 2, pp. 156-76.
Corresponding author
Jeaneth Johansson can be contacted at: Jeaneth.Johansson@ies.luth.se
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