headlines announced that most of the major Wall Street banks agreed
to pay huge fines without admitting that financial analysts lied
in their research reports, McIntire
Professor Bill Wilhelm took a contrarian position about what should
“I wouldn’t hop on the bandwagon for dramatically changing
the way we regulate the interface between investment banks and research,”
says Wilhelm, disagreeing with a media outcry for increased government
No Reward in Stretching the Truth
“We looked for evidence that analysts’ overstating their
case in research reports had a significant bearing on the chances
the bank they were working for would get the deals they were seeking,”
says Wilhelm, who studied more than 16,000 U.S. debt and equity
offerings sold between December 1993 and June 2002.
In fact, Wilhelm and his colleagues, McIntire Associate Professor
Felicia Marston and Alexander Ljungqvist from the Leonard N. Stern
School of Business at New York University, found very little evidence
that analysts’ behavior served the interests of the banks.
In some instances, that behavior may even have undermined the banks’
chances of winning business.
“There is no doubt that some of these analysts were reaching,
and there is no doubt that they were under pressure from the investment
banks,” says Wilhelm. “But this conflict of interest
has always been around.”
Unraveling the Complexity
So, if analysts and their banks did not achieve gains, then why
the pain of lost reputations and business? Wilhelm believes several
factors upset the equilibrium in the investment banking scene.
“With the substantial deregulation of the commercial banking
industry in the last decade, commercial banks, with their bigger
balance sheets and greater lending capacity, became powerful competitors
of investment banks, particularly
in the debt markets,” says Wilhelm. “Commercial banks
were offering issuing firms loans on relatively good terms but tying
those terms to the firms’ securities underwriting transactions.
That’s where they were earning the big fees.”
According to Wilhelm, the investment banks could not match commercial
banks’ lending capacity, but they did have a deep reserve
of reputation capital. “When analysts overstate their case,
they are essentially liquidating their reputation capital,”
he says. “On the whole it was not an effective strategy, but
taking a narrow view in some cases, it looked like an effective
way of fending off the competition.
“Other factors were the huge influx of naïve retail investors
in the market during the dot-com boom and the enormous number of
transactions that created a larger fee pool from which analysts
were compensated. That further tilted the balance that made analysts
willing to sacrifice their reputations.”
Taking a longer historical view, however, Wilhelm thinks the problem
is probably a transitory one and that market forces will bring the
conflict in check without increased government oversight. In fact,
it is Wilhelm’s unique historical perspective that informs
his research on how financial intermediaries — bankers, brokers,
and market makers, for example — adapt to changes in technology
Bankers Out of a Job?
Wilhelm’s recent book, Information Markets, co-authored
with Joseph Downing and published in 2001 by Harvard Business School
Press, charts the implications of the tremendous growth in both
information technology and in financial theory — and the intersection
of the two.
“I view the interface between finance and technology as a
first-order consideration right now,” he says.
Wilhelm makes the case that as financial knowledge is codified and
written into computer programs, the people responsible for conveying
that information to their clients—investment bankers, for
example — may be out of a job, or at least the job as it is
currently defined. In a new book in progress, Wilhelm explains the
history of investment banking from a technological point of view,
emphasizing how technological advances are changing the very structure
of the industry.
For Wilhelm’s McIntire students, his research has important
implications both in the classroom and beyond. In a recent cross-disciplinary
collaboration, students from Wilhelm’s finance class and students
from Assistant Professor Stefano Grazioli’s IT class divided
into mixed teams. Each team built financial software that would
facilitate maintaining the value of a $20 million portfolio over
a period of turbulent market conditions.
Wilhelm’s students learned several lessons from the competition.
“I wanted them to have a firsthand experience of how powerful
financial theory is. It is why program trading is becoming so important.
Of course, in order to codify, you need to understand the theory
very clearly, so the competition was a good way of making these
ideas stick in their minds. It also gave my finance students an
opportunity to work with technical people, IT students, which is
what they’ll do in the real world.”
Equally important, students became aware that in areas where financial
knowledge is easily codified, certain skills will not be as highly
valued as they are now. “The big money and the opportunity
for careers in the most creative areas of finance, and really in
any industry, are in those areas that aren’t so readily codified,”
he says. “That’s where McIntire students should direct
their career path.”