Investment Banks and Security Analysts influences in corporate governance

Critical Thinking Essay: This paper should provide your thoughts on Investment Banks and Security Analysts influences in corporate governance. Accountants and Auditors, Creditors, Rating Agencies, Investment Banks, Security Analysts and Activist Shareholders all play a role in ensuring good corporate governance. What ethical issues are raised for Investment Banks and Security Analysts and how might they be addressed? How does Investment Banks and Security Analysts “influencer” monitor and influence governance? Investment Banks and Security Analysts Material: Investment Banks and Security Analysts: You can think of investment banks as intermediaries who provide consulting services and who sell new securities on behalf of firms. Related to investment banks are securities analysts whose evaluate securities and make buy/sell recommendations to clients based on their analysis. The issue is whether they should take an active role in selling or recommending only “good” companies who follow appropriate governance practices rather than being “hired guns” who simply take the position that they are only doing what they are hired to do. The premise is that investment banks and securities analysts have access to information that would be difficult for the average investor to obtain so they have insights into firm governance practices that are not otherwise available. Are they responsible for communicating such to potential buyers? Consider the situation facing a small firm wanting to go public for the first time that decides to employ an investment bank to provide services in the form of an Initial Public Offering (IPO). Less than one percent of the firms thinking about going public actually do so since investment banks were traditionally very conservative and selective about whom they would sponsor in an underwritten IPO. From the early 1980’s to the mid-1990’s the failure rate on IPO’s was less than 1% but that changed drastically in the 90’s when the demand for new tech stocks expanded dramatically and investment banking firms brought numerous new issues to the market that quickly failed. For example, in 1999 Pets.com had $5.8 million in revenue and reported an operating loss of $61.8 millions. Merrill Lynch offered the Pets.com IPO in February 2000 and the firm raised $66 million in new capital and Merrill Lynch received $4 million in fees. Ten months later, Pets.com filed for bankruptcy and folded. They even tried to sell the sock puppet that was the logo for the company on E-Bay and found virtually no one interested since putting a face on a sock is not exactly high tech! The governance issue is whether Merrill Lynch had an obligation to decline this opportunity given the high probability of failure. Was it ethical to bring the issue to market and how does that fit with the idea of making money for Merrill Lynch? Another example was that of the now defunct Bear Stearns investment banking firm attempting to sell off its mortgage securities portfolio through an IPO of a firm that would buy the securities from Bear Stearns and thereby transfer the risk to the owners of the new firm. Fortunately for potential investors; this effort failed in late 2007 as the depth of the 2008 financial crises began to become apparent. Sell-side analysts (those who recommend buy/sell decisions to the public on behalf of the securities firms) look at firms in great detail as many of them cover only a limited number of firms or industries and therefore are quite well informed. The issue then becomes one of potential abuse of the power inherent in being a recommending analyst. They can either increase or decrease share prices in the short run based on their recommendations. Again, the ethical issue becomes one of how much responsibility that have in noting and encouraging good governance practices. This link will take you to the SEC site regarding analyst recommendations: www.sec.gov/investor/pubs/analysts.htm Analysts have unique access to corporate information although it may be difficult to maintain that access to insider information if the analyst is negative about the firm. Additionally, those who work for investment banking firms have an inherent conflict of interest problem since the investment banking firm wants a good relationship with firms in order to earn future underwriting fees.