Inside the ‘Black Box’ of Wall Street



  • UT research study lends new insight into earnings forecasts and stock recommendations
  • Most analysts regularly contact executives of companies they cover
  • Public conference calls about quarterly earnings are often followed by private conversations between analysts and CFOs
  • Profitable stock recommendations have relatively little impact on analysts’ compensation

Despite regulations limiting the disclosure of nonpublic financial information, most analysts say private phone calls with corporate managers are a key factor in shaping their earnings forecasts and stock recommendations. In a recent survey of 365 analysts, more than half reported that they make direct contact with executives of companies they cover five or more times per year.

Direct contact with management is so important that one analyst said his company hired an FBI profiler to train analysts “to read management teams, to tell when they’re lying, to tell when they were uncomfortable with a question. That’s how serious this whole issue has become.”

The survey is the basis of a forthcoming study that examines the factors that affect how analysts make decisions and do their jobs, such as the pressure to build relationships with management. The paper — co-authored by McCombs Accounting Professor Michael Clement and professors from the University of Georgia, Texas A&M University, and Temple University — offers insights into an area that is under-studied by researchers of the financial industry.

While hundreds of articles have sought to predict financial analysts’ choices using models and statistics, few have peered into the “black box” of the organizational contexts and personal psychologies that drive analysts’ decision-making.

Regulating Disclosure

The study’s findings serve as a commentary on the Securities and Exchange Commission’s Regulation Fair Disclosure, launched in 2000 to limit selective disclosure of market-moving information to analysts or other key stakeholders prior to the general public.

But respondents noted that companies’ public conference calls discussing quarterly earnings are often followed by one-on-one conversations between analysts and chief financial officers. According to one analyst: “We’re almost back to where we were pre-Reg FD — but not quite, because that backroom chatter is shut down. It’s just now it’s not in the backroom; it’s everywhere.”

Nearly 40 percent of analysts said it was very likely they would lose access to management or be frozen out of question-and-answer sessions on conference calls if they issued an earnings forecast well below the Wall Street average.

Influences on Compensation

The survey also found that accurate earnings forecasts and profitable stock recommendations have relatively little direct impact on analysts’ compensation. Standings in analyst rankings and broker votes carry much more weight — two-thirds of the surveyed analysts identified those factors as “very important” in determining their pay.

“This makes for a very fine line analysts must tread when working for their clients, maintaining these important connections, and following the law,” Clement writes.

Or, as one analyst put it, “Most of the sell side is worried more about what management thinks of them than they are about whether they’re doing a good job for investors.”

Other Implications

Clement says that while the study “will bring more attention to Wall Street analysts and their connections to the companies they research and report on, it will also shape the education of future analysts and possibly the regulations by which these analysts must abide.”

Other insights from the survey include:

  • Approximately one-quarter of analysts feel pressured by supervisors to lower their earnings forecasts, presumably because outperforming forecasts pleases investors.
  • Approximately one-quarter of analysts feel pressured by supervisors to raise their recommendations, presumably because it is easier to get their clients to buy rather than to sell the stocks they recommend.
  • Only half of analysts considered primary research “very useful” in forecasting earnings or recommending stocks.

For further analysis of the study, see recent coverage in The Wall Street Journal and CNN Money.


Faculty in this Article

Michael Clement

Professor; KPMG Faculty Fellow in Accounting Education McCombs School of Business

Accounting Professor Michael Clement researches financial reporting, financial analysts, security market valuation, and other topics.

About The Author

TXE Staff

Staff, Texas Enterprise

The Texas Enterprise staff covers a broad swath of disciplines and interests. Writers, researchers, technicians and artists all contribute to the...

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