Buying Stocks? Don't Listen to Investment Banks
ANN ARBOR, Mich. Independent research firms' buy recommendations outperform those of investment banks, according to a University of Michigan Business School researcher.
A new study, co-authored by Reuven Lehavy, assistant professor of accounting at the Business School, found that from 1996 to mid-2003 buy recommendations issued by securities firms with no investment banking business outperformed the buys issued by analysts at investment banks by an average of about 8 percentage points annually.
In contrast, hold-and-sell recommendations coming from investment banks outperformed (on the downside) those of the independent research firms by 4.5 percentage points annually.
According to Lehavy and colleagues Brett Trueman of the University of California, Los Angeles, and Brad Barber of the University of California, Davis, investment bank buy recommendation underperformance was concentrated in the period subsequent to the NASDAQ market peak, when it averaged 17 percent annually.
More strikingly, during this period the subset of investment bank buy recommendations outstanding subsequent to equity offerings underperformed those of independent research firms by almost 22 percent annually, they say.
"These results suggest that the underperformance of investment bank buy recommendations was at least partly due to a reluctance to downgrade stocks whose prospects dimmed during the early 2000's bear market, as claimed in the SEC's Global Analyst Research Settlement," Lehavy says.
The SEC and other regulators recently mandated that 10 of the largest investment banking firms provide independent research to their clients. Additional analyses found that the underperformance of investment bank buy recommendations extended not only to the 10 investment banks sanctioned in the SEC's research settlement but to non-sanctioned investment banks as well.
"This uniform underperformance suggests that differentiating between the sanctioned and non-sanctioned banks, in terms of the requirement that independent research be distributed to clients, may not be justified," Lehavy says.
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