Research in the News
Not a Level Playing Field: How Big Investors Benefit from Selective Access
— December 20, 2011
Economist Intelligence Unit - Executive Briefing
(C) 2011 The Economist Intelligence Unit Ltd.
The title of a research paper by Wharton accounting professor Brian J. Bushee and two colleagues is in the form of a question: "Do Investors Benefit from Selective Access to Management?"
The answer, the paper strongly suggests, is yes. Bushee and co-authors Michael J. Jung and Gregory S. Miller define selective access as the opportunity for investors to meet privately with management in individual or small group settings at invitation-only investor conferences. These conferences are typically webcast to allow access to those unable to attend in person.
The authors focus on two such opportunities for private interactions. The first is formal off-line meetings outside of the webcast presentation; the second is CEO attendance at the conference and the ability to mingle with him or her in casual hallway discussions or in more formal meetings.
The conferences -- usually multi-firm events sponsored by brokerage firms and organized by their sell-side analysts -- are designed to bring the brokerage's buy-side clients together with corporate clients as a way to generate revenue for the firm through increased trading volume and commissions. "Unlike other forms of voluntary disclosure, conference presentations are not tied to a specific information event, such as earnings announcements," note the authors. Jung is a professor at New York University's Stern School of Business; Miller is a professor at the University of Michigan's Ross School of Business.
Investors who choose to attend the conference in person "are often able to meet with managers outside of the presentation," the authors write. "This selective access potentially conveys an information advantage by allowing attendees to ask specific questions to elicit 'mosaic' information that is valuable only in combination with their private information, to assess nonverbal cues in a less rehearsed setting, and to possibly benefit from intentional or inadvertent material disclosures by managers."
The benefits that accrue from such access to a company's top management appear to be substantial, including "significant increases in trade sizes" and "significant potential trading gains." While Bushee and his co-authors are careful to state that they "cannot conclusively determine that managers are providing selective disclosure in the off-line settings, our evidence does suggest that selective access to management conveys more benefits to investors than public access even in the post-Reg FD period."
Regulation Fair Disclosure (Reg FD), passed in 2000 as a way to bring more transparency to the capital markets, requires publicly traded companies to disclose any material -- i.e., relevant -- information to all investors at the same time. But as Bushee notes, while Reg FD prohibits "selective disclosure" of information, it does not prohibit "selective access."
The point of Reg FD was "to level the playing field for individual investors," says Bushee. "I think it has worked in terms of no longer allowing information that is clearly material -- such as earnings forecasts -- to be given out selectively." But there is still significant demand out there among large investors -- including actively-trading mutual funds, hedge funds and investment advisors -- to get access to management "so that they can supplement their own 'private information' with comments from the CEOs."
If a CEO told an investor privately that earnings would be $1.10 a share rather than $1, that is information an investor could trade on, and it would be in violation of Reg FD, Bushee states. "What selective access does, however, is reward investors for collecting their own information. Say that you are a big investor and you ask a manager why the price of tuna is getting so high. The manager says he has heard that the tuna are swimming lower than they have in the past, which means they are harder to catch. Is that material information? It's not clear how I would trade on that if I heard it as an individual investor. But if I'm one of the big investors, then I no doubt come to the meeting with a lot of private information collected from industry analysts, research we have done into other companies and so forth. It's as if I have been missing just one piece of the puzzle. That piece wouldn't be valuable to someone who hasn't collected the rest of the pieces. But it's valuable to me."
The authors looked at transcripts from a sample of 7,668 conference presentations between 2003 and 2008. About half of the conferences had formal off-line meetings outside of the webcasts. While some conferences scheduled one-on-one meetings between certain investors and managers throughout the conference day, others provided "'breakout sessions' in another room immediately after" the end of the presentation, the authors write.
In the off-line sessions, investors were able to ask specific questions without having to share that information with other investors in a public setting. In addition, the authors write, investors could see "nonverbal cues in managers' responses (or non-responses) to questions in a less-rehearsed setting." These nonverbal cues include, for example, managers showing unwillingness to answer a certain question, or exhibiting body language that suggested they were hiding information.
"We're looking at meetings that are offline, so it could be that managers are giving our material information in exchange for favors," says Bushee. "Or it could be that when a CEO stands up and presents in front of a crowd, he or she is rehearsed and poised and confident, but in a small group, he may let his guard down and say something he shouldn't. Or perhaps it is a case where investors have worked out hand signals with CEOs" that translate into silently shared information.
While managers are advised "to take particular care not to release material information during these meetings, managers could intentionally or inadvertently selectively disclose information," the authors write. CEOs, rather than CFOs or lower functional managers, are the best sources of information.
"It's all about getting access to the managers so you can ask the questions you want to ask," says Bushee, offering an anecdote that backs this up. "Shortly after 9/11, there was a big cutback in travel and a small uptick in the use of virtual conferences. Everyone could stay in their offices and have the same interaction via interactive webcasts. Those virtual conferences died off almost immediately because it's not what is actually talked about in open webcasts; it's about being there and having those personal interactions."
Getting on the 'A' List
In an attempt to measure the trading gains that accrue from selective access, the researchers first looked at changes in trade sizes. They found "significantly greater increases in trade sizes in the hours before and after the presentation for firms providing one-on-one access throughout the day, and in the hours after the presentation for firms providing breakout sessions immediately after the presentation." They found the same significant increases in the hours after the presentation when the CEO is present.
The researchers then looked for evidence as to whether selective access results in profitable trading opportunities, and found that firms providing off-line access experienced "significantly greater potential trading gains over three- to 30-day horizons after the presentation than firms only providing presentations." In the case of off-line access, "investors are not only changing their beliefs based on their private access to management, but their trades appear to be profitable over a short horizon," the authors note. They saw no significant trading based on CEO attendance.
Investor conferences, which were relatively rare before the passage of Reg FD, have since "exploded" among individual brokerage houses, says Bushee. Whereas there used to be luncheons for groups of analysts and company managers, "analysts now want to host this access in-house. The ability to offer access to buy side investors in exchange for the business from investors trading through the analysts' brokerage business is too lucrative to share with other analysts."
The way that big investors get invited to these conferences is to run a significant portion of their trading business through the brokerage firms, Bushee adds. "Buy side investors say about a quarter of the commissions they pay for their trading is to compensate analysts for giving them access to management."
Bushee's research raises the obvious question: Is the system rigged so that only the big, actively trading investors benefit while the small investors get left in the dust? Is this another example of what the Occupy Wall Street movement is protesting against? "One of the things that often comes up when I present the results of our research is the question of whether or not the SEC should outlaw these selective access meetings," says Bushee. "I don't think it should, because if you outlaw them, then investors and managers will find some other way to circumvent the law." In addition, Bushes notes, there is a benefit to these meetings because "frequently managers have information that is complicated and may be very sensitive. Openly disclosing it would confuse unsophisticated investors, which could lead to price volatility. So to the extent that well-functioning markets need information, one of the best ways to get it is to funnel it only through sophisticated investors."
At the same time, says Bushee, more disclosure would help. "It would be nice to know which investors get this access -- i.e., how often they get to go to these invitation-only meetings -- because as an individual investor, I'm never going to have a level playing field. But I can decide to put my money into funds that have these kinds of advantages."
Has the financial crisis had an effect on the number of conferences held and investors who attend? "We don't know yet," says Bushee, adding that one impact of the crisis was the death of two of the largest brokerage firms -- Lehman Brothers and Bear Stearns. "A lot of access was facilitated by those two firms. But again, it gets back to the question that if you have financial services firms doing incredibly complicated derivatives trading, would it help individual investors to hear the details of that? Probably not. As the world gets more complex, individuals are already at a big disadvantage."
The investors who attend these conferences, Bushee adds, "would argue that the biggest reward comes from hard work. The more you prepare in advance for your five minutes with the CEO, the more information you gather about the industry. That gives you better information. It still seems bad, but not as bad as it was before Reg FD was passed, when access got you the answer as opposed to a piece of the puzzle."
Executive Briefing 20 Dec 2011 (T11:19), Part 1 of 1
The Economist Intelligence Unit, N.A., Inc.