Sell-side Analysts Are Destroying America (Apparently)

Matt Levine at DealBreaker:

Here’s sort of a pleasing paper on equity research analysts. The background is basically that there’s this constellation of questions that reduce to “do public markets make companies Bad?,” and one of the main mechanisms by which that might happen would be if markets make companies focus on short-term earnings and shareholder distributions rather than long-term value creation for all stakeholders through sustainable innovation. So you try to find ways to measure (1) how public a company is and (2) how innovative it is, more or less, and then see how they interact. Analyst coverage is sort of a proxy for, like, intensity of public-ness,¹ while patents are sort of a proxy for innovation.² So does more research coverage make companies more or less innovative?

In terms of economic significance, our analysis suggests that an exogenous average loss of one analyst following a firm causes it to generate 18.2% more patents over a three-year window than a similar firm without any decrease in analyst coverage.

Note the “exogenous”: if you just look at raw analyst coverage versus patents, you get “a positive raw association between analystcoverage and the firm’s innovation output,” which is sort of obvious; Google and Apple have more analyst coverage and more patents than, say, Yummy Flies, Inc.³ When you control for things like company size, etc., though, fewer analysts goes with more and more influential patents. The authors also look at some quasi-natural experiments – like: if two brokerage firms merge and fire one of your analysts, your analyst count goes down for no real reason – and find that these no-real-reason analyst changes significantly correlate with future innovation. Which suggests there’s some sort of causal relationship between coverage and innovation. Then there’s a lot of regressions and stuff....MORE