What is and Why Paid-for Independent Research?
Paid-for or issuer-paid independent equity research is research provided by firms that do not have any investment banking and other consultancy relationships with the company that is the subject of the report and the research provider is compensated by the subject company. Because the independent research provider does not have investment banking relationship with the subject company it has no interest to write the research reports in such a way to generate trading commissions. The outcome is that equity research prepared by independent research providers would be unbiased and objective.
Companies with any market capitalization can seek the research services of independent research providers. In fact one of the original factors that brought the importance of independent research coverage to the surface was the $1.4 billion global settlement between the regulatory authorities, New York Attorney General , and the ten major brokerage firms in December 2002. That agreement had many terms one of which was “an obligation by the ten major brokerage firms to furnish independent research for a period of five years. See the following link for details: http://www.nasd.com/PressRoom/NewsReleases/2002NewsReleases/NASDW_002864
However, the main need for independent equity research both from the investors’ point of view and from the issuer's point of view is in the small cap and micro cap segments of the equity market. As a result of recent consolidations in the brokerage industry, traditional analysts’ research coverage is concentrated in the hands of a few major brokerages houses; and these major brokerage houses main interests are in the large cap companies because of investment banking relations and trading commissions. Large brokerage firms don't seem to have any incentives to cover smaller companies. As a result most small cap and micro cap companies have been left with no analyst coverage. This reality is well recognized by the authorities. The “Final Report of the Advisory Committee on Smaller Public Companies to The U.S. Securities and Exchange Commission” dated April 23, 2006 reports that whereas for companies with over $10 billion market cap the mean number of analyst is 17.2 and for those with market cap between $5 to $10 billion is 13.0, when it comes to smaller companies the mean number of analysts covering these companies is 1.4 for companies with market cap between $100 to $200 million, 0.4 for those with $50 to $75 million market cap and 0.0 for the companies with market cap below $25 million.
Lack of research coverage for smaller public companies is harmful both to the companies and to the investing public. This is best described in the above mentioned advisory committee’s report in the following terms:
- Companies with no independent analyst coverage have a reduced market capitalization in comparison with companies that do have such coverage, and are subject to higher financing costs when compared with their analyst-covered peers;
- A lack of coverage by independent analysts limits shareholders’ and prospective shareholders’ ability to obtain an informed outsider’s perspective on identifying strengths and weaknesses and areas for improvement;
- The lack of coverage lessens the entire “mix of information” made available to investment bankers, fund managers and individual investors, which make markets less efficient; and
- Because analyst reports trigger the buying and selling of shares, the lack of such reports frustrates the formation of a robust trading market.
To address the need for more independent research for smaller public companies one of the recommendations of the Committee to the SEC was that:
-
Maintain policies that allow company-sponsored research to occur with full disclosure by the research provider as to the nature of the relationship with the company being covered. Entities providing such research should disclose and adhere to a set of ethical standards that ensure quality and transparency and minimize conflicts of interest.
Copy of the Final Report of the Advisory Committee can be found at:http://www.sec.gov/info/smallbus/acspc/acspc-finalreport.pdf#search=%22final%20report%20of%20the%20advisory%20committee%20on%20smaller%20public%20companies%22)
Independent research is now moving in to cater for this deficiency of research coverage for smaller companies and Alpha Beta Investment Research is pleased to be part of this task force.