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It can't always be about the money

Should analysts own shares in companies they cover?
Thursday, February 18, 2016 - 14:18

Should research analysts own shares in companies they cover? This is one of those questions (much like the usefulness of quarterly reporting) that elicits different responses depending on who you ask. There exists a school of thought which says unequivocally "yes'', the reasoning being that if analysts literally put their money where their mouths are, then it lends that much more credibility to recommendations. I've read comments from fund managers along these lines: "I would be much more prepared to buy a stock based on a recommendation by an analyst who owns shares in that company because it's in his interests to make sure the advice is sound''.

Ah, but then what about objectivity, you might ask? Isn't research supposed to be independent? And you'd be right to ask this because how likely would it be to expect anyone to release a "sell'' on a stock that is owned, presumably in some meaningful quantitiy?

What's more here we then enter into debatable territory, because what is "meaningful'' for one may not be for another. Would 10,000 shares be sufficient to qualify? Or should it be 100,000? Is there a credibility threshold? Is an analyst who owns 100,000 shares less objective that one who owns 500,000? Would readers then be prepared to give greater weight to a report written by someone who owns more shares than one prepared by someone who owns fewer shares? 

For that matter, let's extend the question to independent directors. Some people might argue that such officers should own shares in companies on whose boards they sit because then their goals would be aligned with other senior managers but I believe that very few actually do. This is pretty telling to me because the rules I believe do not forbid independent directors from owning shares in their companies. So I think the majority refrain because it's simply the right thing to do in order to properly discharge their fiduciary duties.

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If analysts and independent directors are both meant to be objective, non-partisan observers of companies and their performance, and if most independent directors don't own shares, then I think the same should apply to analysts.  Fortunately, in my experience I have not seen many research reports prepared by analysts here who own shares in the company being analysed. In fact, if I were to really think about it, I can't recall any instances, which is encouraging.

Independence is a state of mind and in the interests of good governance, it's best not to own shares in companies which one either covers as an analyst, or polices as an independent director. After all, it cannot always be about the money.

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