Today's Analyst Often Wears Two Hats Lowenstein, Roger. Wall Street Journal. (Eastern edition).

New York, N.Y.: May 2, 1996. pg. C1, 6 pgs

The wonderful thing about a hot market for initial public stock offerings -- wonderful, that is, for underwriters -- is that deals come too fast for customers to remember how the previous pitch fared. Who, for instance, recalls the early excitement about Alteon, Inc.? The biotechnology firm went public in 1991. "Though it has just 30-odd employees and no sales in sight, Alteon saw its total market value balloon," this newspaper reported after Alteons first and best day of trading. Buoyed by the "huge" potential for products as yet unapproved, the stock, offered at $15, nearly doubled. Alex. Brown & Sons, the lead underwriter, followed soon with a "Buy" recommendation at $24 a share. You know the rest. Two years after the IPO, Alteon was trading at $10. Alex. Brown's clients now may dispose of their shares at about $12.375. In recommending what turned out to be a lemon, Alex. Brown was hardly alone. Two scholars, in fact, have looked at every IPO (save for the tiniest) in 1990 and 1991, focusing on which were recommended and by whom. Their intent was to test the objectivity of underwriters. If such objectivity exists, the scholars -- Roni Michaely of Cornell and Kent L. Womack of Dartmouth -- had trouble finding it. Companies that were recommended by their lead underwriters bombed. Companies that won "independent" Buy ratings -- that is, from firms who were not their lead underwriters -- did vastly better. The size of the gap is startling. A year after the recommendation date, companies touted by their underwriters trailed the market by eight percentage points -- and trailed the independently touted IPOs by 21 percentage points. Measured from the time of the IPO, the record of underwriters was even worse. After two years, companies blessed with a Buy from their underwriters lagged behind the market by 15 percentage points. The other group beat the market by 42 points. (It should be said that despite Alex. Brown's slip with Alteon, the overall results of its IPOs, and of its recommendations, were a good bit better than the average underwriter's.) Flipping the results, 12 of the 14 biggest underwriters were better at analyzing other people's IPOs than their own.

Messrs. Michaely and Womack differ from most financial scholars in that they write in English. Thus, we may quote their conclusion plainly: "The recommendations by underwriter analysts show significant evidence of bias and possible conflict of interest." Nor do the writers stint from identifying the source of conflict: Analysts get paid, in part, according to their contribution to corporate finance. To bring a company public, a firm needs its analyst on board. It is the analyst that explainsand implicitly, trumpets -- the investment merits of the offering. After the IPO, it is awkward for the analyst not to recommend it. Yet the analyst's incentive to nurture IPOs conflicts with his role as an objective stock-picker. (In this study, which covered roughly 400 IPOs, companies that weren't recommended by anyone actually did a bit better than those recommended only by their bankers.) The authors propose that analysts may be swayed by overexposure to clients as well as by naked self-interest. Spend enough time with a client, and you fall in love with him. Regardless of whether analysts are succumbing to pressure or are unwittingly falling for their own pitches, the real explanation lies in the changed nature of the job. A generation ago, many analysts made a living wholly on stock-picking ability. Wall Street was dotted with boutique research firms that did no investment banking at all. That pure stockpicking job was "heaven," in the words of one well-respected veteran analyst -- but it is a heaven that now scarcely exists. When commissions on stock trading fell, investment research (which generates trading) no longer paid the freight. Today, analysts are supported partly by their corporate finance departments. And much of what they do -- marketing and preparing IPOs, for instance -has little to do with pure research, and much to do with investment banking. In the U.S. in particular, investment banks have persuaded clients to hire underwriters on the basis of their analysts' selling power. That has led to higher underwriting fees than in Europe. In turn, the analyst's worth is increasingly dependent on his or her ability to bring in deals. Brian Kritzer, a blunt-speaking analyst at Van Kasper & Co., a regional California firm, likens an analyst's role in an IPO to selling one's soul to the devil. But one need not be so cynical. "People are not as penetrating in their questions when they are dealing with a client that is paying them money," says John Hoffmann, head of research at Smith Barney. Since this is unlikely to change, investors, journalists and others who deal with the Street would do well to keep in mind that, often times, the analyst is wearing two hats.