Equity analyst recommendations and IBES: rewriting history

Just when you though corruption allegations might be abating in equity markets, along comes an explosive new study. A paper to be delivered to the January 2007 American Finance Association annual meeting in Chicago suggests that investment analysts' historical buy recommendations have been manipulated to put them in a better light.

Rewriting History, by Alexander P Ljungqvist (Stern School of Business, NYU), Christopher Malloy (London Business School) and Felicia Marston (University of Virginia) provides evidence that nearly 20,000 records in I/B/E/S, a database of research analyst recommendations owned by Thomson Financial and widely used by investment professionals and academics, were manipulated between September 2002 and May 2004. This took the form of selective, ex post removal of analyst's names from some of their historical recommendations. These were not random; they were concentrated among the worst performing recommendations. Here is the authors' abstract:

Comparing two snapshots of the entire I/B/E/S analyst stock recommendations database, taken in 2002 and 2004 but each covering the same time period 1993-2002, we identify nearly twenty thousand changes of an unusual nature: the selective removal of analyst names from historic recommendations (“anonymizations”).

This practice turns out to be pervasive and non-random: Bolder recommendations are more likely to be anonymized, as are recommendations from more senior analysts, Institutional Investor “all-stars,” and those who remain in the industry beyond 2002. Abnormal stock returns following subsequently anonymized buy recommendations are significantly lower (by up to 11.0% p.a.) than those following buy recommendations that remain untouched, suggesting that particularly embarrassing recommendations are most likely to be anonymized.

Analysts whose track records appear brighter due to anonymizations experience more favorable career outcomes over the 2003-2005 period than their track records and abilities would otherwise warrant.

As the authors note, the period not only coincided with close scrutiny of Wall Street research by regulators, Congress, and the courts, but also saw a substantial downsizing of research departments of major brokerage houses in the US. The manipulation benefited the careers of those whose dud recommendations were anonymised. The paper concludes:

Whether or not analysts were in fact behind these changes, however, their track records undeniably look better than they should, and we show that the analysts concerned apparently benefited in the sense of experiencing more favorable career outcomes than their track records and abilities would otherwise warrant: Anonymizers are more likely to move jobs, to be hired by a large brokerage firm, and to move from a small to a large firm (Hong, Kubik, and Solomon’s (2000) measure of a promotion). Anonymization easily has the largest economic effect in our career outcome models.

These are very disturbing findings, and as the authors note, given the "non-random nature of the results" it is very unlikely they are attributable to chance. While "it is possible that the brokerage firms were in fact the culprits ..the patterns we document seem at odds with this interpretation".

If this is not market manipulation, I don't know what is. Let's hope Eliot Spitzer or the SEC investigate.

Comments

[me]

I don't think Spitzer will be investigating, he's about to be elected governor of New York state.

[Lafayette]

Ho hum. Boring story.

How do you know when Equity Analysts / Brokers / TV-stockmarket-experts are exaggerating? When they move their lips.

[mentalmodel]

It's certainly an interesting observation. I wonder if there were negotiations between the analysts and Thomson financial that lead to the practice -- If you don't let me delete my embarrasing call, I'll stop providing you with new data.

There is at least one service available that should effectively detect this (I wonder if it does). It costs some outrageous amount of money. Then again, I/B/E/S by itself is certainly not cheap, and I'm sure you probably need to be an accredited investor just in order to purchase it.

[The Unknown Professor]

Mentalmodel:

In the case of IBES,the service you mentioned (Quantitative Analytics) wouldn't have helped - they are owned by the same firm as I/B/E/S (Thomson Corp).

However, Thomson has aggressively responded to Ljungqvist et. al. -- they were quoted in a an article in today's Financial Times, and actually emailed me (and, I'm sure, other bloggers) to respond. They claim the data necesary to track the changes was available in another file that Ljungqvist et.al. missed.

I'm not commenting on whether or not their story is true (or even reasonable), but I have posted it on my blog so you can see for yourself. The link is

http://financialrounds.blogspot.com/2006/11/revisionist-revisions-at-ibes.html

I'd like to think their story is valid, since I've used I/B/E/S in my research, and would like to continue to do so.

But time will tell. I'm sure there will be other information forthcoming in the near future. The IBES story is pretty big, since it's a major resource both for academics and real-world practitioners. So the stakes are pretty high for Thomson (the provider of I/B/E/S)

[Lafayette]

"a database of research analyst recommendations owned by Thomson Financial and widely used by investment professionals and academics, were manipulated between September 2002 and May 2004."

How is it that IBES records are allowed public accessibility without an attribution of the source inputting the data, if not the author at least the company to which the author is affiliated.

This sort of manipulation is assimilated with "line fraud" for which the laws are already explicit. The fines are heavy for the companies and any condemnation is penal for the individuals.

It is a matter for the local DA to prosecute (or not) based upon the accusations, wherever the database was maintained.

[Lafayette]

"They claim the data necesary to track the changes was available in another file that Ljungqvist et.al. missed."

This is insufficient and may not be apparent necessarily to the file user. If filed information changes, for any reason whatsoever, and especially so if the identification of the source is altered, then a trace is required.

Tracing information of a public nature that assesses the worth of a corporation deserves a limpid identification of the source (meaning who is accountable for that information.)

There is a case of fraudulent misuse of a public information source within a commercial context. Remember, there is no "peer level" review in this context of the public information.

[The Unknown Professor]

Lafayette:

I don't have a dog in this fight (except for my desire that the data source remains usable for research purposes.

But the I/B/E/S data set is not "public" in the same sense that financial statements are. It is available only at a fairly steep price to the general public--academics get it for around $4k per year, and I'm sure the price to the general public is many multiples of that. In fact. academics get a break only because they use it for research (i.e. non-commercial) reasons.

Since it's available at a high price only, it will be purchased only if it has a reputation for validity. So if there really was manipulation going on (or if it was a systems problem that users were unaware of), Thomson has a strong financial incentive to rectify the problem.

If there wasn't, they have a strong incentive to get their side of the story out.

So either way, since Thomson has a great deal of money riding on it, I think that reputational concerns will be the driving force.

[Lafayette]

"But the I/B/E/S data set is not "public" in the same sense that financial statements are. It is available only at a fairly steep price"

This means that it is not only public but that fraud was probably committed and not just manipulation of misinformation.

Why ever erase their names from the file? Modesty? Ha!

Just one more reason that Thomson should be brought to task, with a monumental fine as a salutary lesson to others who have or would manipulate or remain anonymous from public data.

There is simply NO excuse for what happened. None.

[The Unknown Professor]

Lafayette:

I'm not a lawyer, so I can't comment on whether (and again the claim of "anonymizing" at this point is a claim, that's all) fraud occurred. I also don't know what warranties (if that's the proper word) Thomson made about the data.

All I was saying is that the bases for the success of I/B/E/S as a data source are its comprehensive nature and the integrity of its data. If the data's integrity turns out to be compromised (and I'm still willing to be convinced either way), Thomson will suffer a pretty big hit to their business. And not only for their IBES product but for others. After all, their product is information. If the info is bad, they'll lose business.

And they may be liable to lawsuits. But again, I'm not a lawyer, so I really am not qualified to make a judgement on that issue.

[Lafayette]

TUP: "All I was saying is that the bases for the success of I/B/E/S as a data source are its comprehensive nature and the integrity of its data."

I would like to assure you that such is not in question. But, first, answer why ever would one want to have their attribution erased from the file? What is the motive?

Simple housekeeping? That's foolish and negligent. Administrative error? That's negligence as well. Management decision? That's willful and therefore introduces liability. Discovery that the data assumptions were unreliable? That's permitted, but merits a public explanation.

All of which seems to indicate that mischief may have been about.

[ChrisA]

Relying on investment banks analysis to guide your investment is the same a relying on astrology. By definition if the analysts (or astrologers) really had the ability to have the insights they claim they would not need to sell them to you. It does amaze me how much money can be made from this racket though.

[The Unknown Professor]

Lafayette:

I agree with you wholeheartedly that there was motive for analysts to have their forecasts anonymized. That's thw whole point of the paper.

One of my research areas is agency-related topics, and I'm never surpirsed when skullguggery takes place. I'm just saying that I'm not convinced yet that it took place here. Quite possibly it did, but I'm still open minded about it.

Either way, we'll find out soon enough. The paper has created quite a stir. And since the street is a major consumer of academic research on investments, I doubt the news will quietly fade away.
So, the onus will be on Thomson to answer it.

[Lafayette]

"By definition if the analysts (or astrologers) really had the ability to have the insights they claim they would not need to sell them to you. It does amaze me how much money can be made from this racket though."

Companies court the analysts fervently in order to get favorable reviews from analysts. That some analysts succumb is a known fact.

I've made presentations myself, and have over-hyped expectations in a pointed effort to get a good opinion. Rarely was I ever asked to corroborate my "information". But, I also expected that my "facts" were discounted as well by most. It is a silly game of "I know that you know that I am exaggerating the truth".

In fact, to get good objective information, it is best to see a company's competitors, who will exaggerate in the opposite direction - or sometimes confirm a really good competitive position of an adversary. It takes good detective work and those who do it well are valuable people. Maybe their opinion justifies the cost ... but how to separate the wheat from the chaff? By looking at past analyses and tracking their performance. But, that is a pain in the backside.

I think the best thing to do is concentrate on investing in a particular sector that one knows well and watch the information coming out. This is typically a sector that one works in and is familiar with the players.

As for the rest, I put my money in index funds and let the average take care of the rest. No fun, but I've got better things to do with my time than watching the stock ticker.

[ChrisA]

Lafayette
"It takes good detective work and those who do it well are valuable people."

I agree, which is why their services are no use to you or I. The whole third party money management industry (investment banks, analysts, hedge funds etc) seems to me to fall foul of this problem. On one variation of the efficient market theorum if there is any possible rent at all in professional analysis it will be taken by the analyst. In other words, unless the analyst gets all the rent why would he share the opportunity with you, since he can take the rent in other ways. So, as soon as a analyst becomes aware (perhaps through benchmarking) that he can achieve superior performance, he should raise his price to take away any advantage. Historical over performance without higher prices should raise suspicion of the sort of effects decribed above. What amazes me though is that many trillions are invested by fairly sophisticated investors using professional money management rather than through indexing - basically giving away money.

Since I generally assume that markets in general are efficient why is this so? I think it is a hangover from the days when investing in securities carried very high transaction costs (through cartels and primative data systems). This meant that it was much more efficient for people to invest through bulk buying in company pension systems. A pension scheme needs professional managers. Today though you can directly invest very easily but vast sums remain in pension schemes through inertia. Which just reminds me what a terrible idea company pension schemes are, a structure almost designed for agency problems.

[Lafayette]

"On one variation of the efficient market theorum if there is any possible rent at all in professional analysis it will be taken by the analyst. In other words, unless the analyst gets all the rent why would he share the opportunity with you, since he can take the rent in other ways."

This doesn't hold. The analyst has no privileged access to information. They will therefore be obliged to share it with whoever is investigating along with them.

If an analyst did have privileged access, then there would be, quite likely, theft/leakage of confidential information – which puts that information into another domain, that of public journalism.

Obtaining information is one part of the work, interpreting it is another and presenting it is a third. The analyst must compete in all three, since each differentiates the "service".

You are presuming that the service provided is common amongst all analysts, when it is their differentiation that allows one to sell more than another (because it pleases more). There is no monopoly rent in the matter.

I suggest also that you are not giving enough attention to the fact that the profession has considerable competitive activity. I think furthermore that it is precisely this factor that tempts some to exaggerate/manipulate the facts (in order to obtain a kick-back from the advantaged party).

The business of business analysis has its Holmes and its Moriaritys.

[Lafayette]

"Since I generally assume that markets in general are efficient why is this so?"

Yes, and I like to think every girl I met I can bed.

To each one's own delusions ...

[ChrisA]

"To each one's own delusions ..."

Lafayette - I assume that you don't believe markets are efficient. I read a nice quote recently on this that said that nowadays the only people who don't believe in markets to set prices are the leaders of North Korea, Cuba and Wall Street money management firms.

Of course if you take the view that markets are not efficient (in general) then there must be arbitration opportunities presenting themselves all the time, thus presenting opportunities to become rich without any risk. I would love this to be true but experience has taught me that this is not the case. You might say that I (and the majority of the rest of the investing public) are simply too dumb to notice them. But that objection is really just agreeing with the efficient market hypothesis - that any clearly perceived advantage is quickly arbitraged away by the market. If I am wrong, why are you wasting time posting here? You should be out making your fortune.

On the comments on analysts, I think you are missing the point - I was not talking about confidential information, just describing the hypothetical analyst who has a particular ability to spot the opportunities through deeper (say) thinking. If this person could demonstrate this skill regularly over time then I would agree that their advice is worth paying for - but, and this was my point, the analyst should be able to get for that advice just about all the rent that that advice creates, leaving me in the position of not being any better off than just randomly investing. All this assumes that analysts can actually even create value through deep thinking - which is a big if.

[Lafayette]

"the only people who don't believe in markets to set prices are the leaders of North Korea, Cuba and Wall Street money management firms."

I believe markets set prices. I don't believe they do so "efficiently". To think that is academic arrogance. One observes that markets set prices through multiple transactions that settle, more or less, on an identifiable price range ... and so it is "efficient".

Believe me; anyone who has the least bit of experience in business will assure you that the above is simply not the case. Prices are influenced by multiple factors.

Next time you are in a jumbo jet flying somewhere, just think of this fact: The price you paid for your seat may either be half that which the person on your left paid and twice that which the person on your right paid.

That's efficient price setting? Right ...

[chrisA]

Lafayette

In this context, efficient means only that the price reflects all available knowledge about the supply and demand for the product, so that any actors chances of making money by buying or selling the product are about equal. Nothing in your post negates that, in fact your point that prices reflect all sorts of factors re-inforces the idea.

In your example, because of the lack of transferability of airline tickets, the airline can charge me, the business traveller who values flexibility, more than a budget traveller who values price first and can plan several months ahead. If we had paid the same amount either the airline is losing on me (because I would have paid more) or it is flying with empty seats because it is charging too much for the budget traveller. The opportunity to charge me more though comes through the lack of being able to transfer tickets except through the airline, otherwise I would buy off the budget traveller. So there is no market in operation here, so it is not a flaw in the market creates efficient prices theory.

An inefficient market would be one where the commodity was fungible and freely tradable (such as a stock) but was priced differently such that you could buy and sell and predictably make money.

[Lafayette]

"In your example, because of the lack of transferability of airline tickets, the airline can charge me, the business traveller who values flexibility,"

I've seen this example before ... in Marketing classes.

In fact, airlines know full well how many of any class of traveler will demand a seat on any given day in any given direction. (They know data mining techniques very well.)

They also know that they will bump a non-frequent flyer to cater to a frequent flyer, unless the law prevents them from doing so - which is now the case where I live (France).

I was only trying to make the point that the D- and S-curves that were employed in EC101 to show us market equilibrium were simplistic for pedagogical purposes. There is no ONE price for any product/service and there may not be even a good way of obtaining either an average or a mean, because the data is unavailable. (All exchanges on the black market generate unrecorded data.) But, this is unimportant.

What is important is the notion that it is the interaction of Supply and Demand that determines prices, daily and dynamically. Why? Because markets function as dependents of those two factors, consumer demand for and commercial supply of goods and services.

This is simple reasoning, between you and me. But, I suspect that the greater part of any population does not know how this mechanism works - though they do have a VERY good idea when a product/service becomes too expensive.

I hear complaints about prices all the time, but rarely do I hear a farmer talking about the coming price increase due to a drought that reduced supply.

The way economies work are still a mystery to a great many people, some of them really quite brilliant in other domains of human endeavour. My point: If we can teach English (or any language in High School) then we should be teaching Economics there as well. At least the easy bits.

[Carel]

Has anyone seen more on this question?

"The majority of changes apply to analysts that were or are now Merrill analysts. Could it be that the sales win that Thompson Financial announced at the end of 2003 for a Merrill Lynch contract estimated to be worth 1Bn USD?"

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