The Global Settlement, All-Star Analyst Departures And Their Impact On The Capital Markets
University of Pennsylvania – The Wharton School
November 2, 2015
Abstract:
The Global Research Analyst Settlement prohibited twelve large investment banks from tying equity analysts’ compensation to investment banking revenues, causing a large number of Institutional Investor “all-star” analysts to exit the sell-side industry. Using a difference-in-differences specification, I find that the departure of all-stars caused their bank-industry underwriting groups to lose equity issuance market share. Market share losses were more severe for IPOs than for IPOs and follow-on underwritings combined. The higher the average quality of all-stars in a bank-industry, the more severe were the bank-industry’s losses. Additionally, the departure of all-stars raised the cost of equity capital for IPOs underwritten by their bank-industry groups, particularly for IPOs that were more difficult to value. Ultimately, the loss of sell-side research talent, an unintended consequence of regulation, forced issuers to accept research coverage of inferior quality, raising the cost of obtaining public capital.
The Global Settlement, All-Star Analyst Departures And Their Impact On The Capital Markets – Introduction
The Global Research Analyst Settlement (the “Global Settlement”) is an enforcement agreement proposed in December 2002 and finalized on April 28, 2003, among the SEC, the NASD, the NYSE, the New York State Attorney General and ten (later twelve) of the then-largest investment banks operating in the United States.1 Allegedly, from approximately mid-1999 through mid-2001, under the pressure to attract investment banking business, research analysts at these banks had been generating research that was tainted by conflicts of interest. The goal of the Global Settlement was to restore the integrity of research by severing the ties between the banks’ research and investment banking divisions. Under the terms of the agreement, the banks were required to make total payments approximating $1.5 billion, including $942 million in disgorgement and penalties, $85 million for investor education, and $460 million to fund independent research. In addition, the banks were required to separate their research and investment banking divisions, adhere to new disclosure rules, and make independent research available to their investing customers by contracting with independent research firms.
This paper studies the impact of the Global Settlement on the capital markets. How did the Global Settlement a¤ect the investment banking deal flow of the sanctioned banks or equity issuers’ underwriter choices? How did the Global Settlement a¤ect the cost of equity capital for issuances underwritten by the sanctioned banks?
These questions are motivated by the evidence documented in Guan, Lu, and Wong (2013) that an exceptionally large number of “all-star” analysts – as named by the Institutional Investor magazine annually for every classified industry – exited the sell-side research profession in the post-Settlement period, due to changes in their banks’ analyst compensation structures as required by the settlement agreement. Specifically, the agreement prohibits research analysts from participating in the solicitation of investment banking business, including any investment-banking-sponsored pitches and roadshows. Furthermore, the agreement requires that an analyst’s compensation not be based directly or indirectly upon investment banking revenues or input from investment banking personnel, but that it should be based in significant part on the quality and accuracy of the analyst’s research.
Since investment banking contributions was one of the major factors in determining an analyst’s compensation prior to the Global Settlement (Groysberg, Healy, and Maber (2011)), the settlement brought significant reforms to the ways in which analysts were compensated. Using proprietary compensation data from a major investment bank, Groysberg et al. document that median total analyst compensation decreased from a peak of $1,148,435 in 2001 to $647,500 in 2005, driven almost exclusively by variation in bonuses, the median of which decreased from a peak of $940,007 in 2001 to $450,000 in 2005. Guan et al. find that investment bank research analysts were on average more likely to leave the sell-side research profession in the post-Settlement period, and that the increase in the propensity of all-star analysts to exit the sell side was significantly higher than the corresponding increase for non-all-star analysts, which is consistent with all-star analysts earning significantly more than their unranked peers (Groysberg, Healy, and Maber (2011)). Additionally, banks appeared to be unable to retain their all-star analysts by promoting or transferring them to positions with higher earnings potential or better career prospects; moving to the buy side – presumably for more lucrative opportunities – became a much more attractive career option in the post-Settlement period for all-star analysts. What were the economic consequences of the loss of top sell-side research talent, caused by a decline in compensation and perhaps by dimming career prospects?
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