In the early days of rock ‘n roll, radio disc jockeys decided which songs got the airplay that would make them hits. To make sure DJs played their tunes, record labels used “payola” in the form of cash or other goodies.
When listeners learned about these payoffs to style-setters they admired, the resulting scandal triggered Congressional investigations and ended a number of careers.
The Wall Street Journal reports that today’s investors have reason to wonder if the opinions of securities analysts about a company’s shares are distorted by a modern form of payola.
With declining stock-trading commissions, brokerage firms increasingly rely on fees they charge institutional investors for arranging private meetings with the top executives of publicly traded companies. Those fees total about $2 billion annually, the Journal estimated.
The CEOs and CFOs of these companies know there’s a high demand for face time with them. A number of them have decided to grant this access only to analysts who publish positive reports about their companies.
Analysts who rate their stock a “buy” get to bring in their institutional investment clients. Those who rate it a “sell” get shut out – and forego the hefty fees they would collect for arranging these meetings.
According to the Journal, success at pulling in access fees can determine a third of an analyst’s annual income. That provides a strong incentive for analysts to write upbeat reports on the companies they cover.
In addition, investment funds are likely to steer stock trades, and their accompanying commissions, to brokerages that are able to arrange private meetings for them with corporate executives.
Individual investors and small funds may still value the opinions of analysts. But that seems to be less true for institutional investors. One analyst says he was sometimes told to sit outside the meetings he had been paid to arrange.
The powerful financial incentives on brokerage houses and their analysts to provide upbeat reports about the companies they cover has put them on a path that is very likely to erode investors’ perception of the value of the advice they provide.
What does this mean for a company’s investor relations program? If institutional investors are willing to pressure analysts in order to get direct access to CEOs and CFOs, why not focus your IR efforts on reaching out directly to these funds? Think about a non-deal road show to communicate your well-presented story to an audience that clearly wants to hear it.