Analyst information intermediation – private and public information –and the central role of knowledge and social forces in economic processes in the ‘market for information’.
John Holland, University of Glasgow, Jo Danbolt, University of Edinburgh, Lei Chen, University of Keele.
John Holland, University of Glasgow, The Adam Smith Business School, University of Glasgow, Main Building, Glasgow, G12 8QQ, Scotland
Abstract:
This paper develops a model of the information intermediation role of analysts in the ‘market for information’ (MFI). It illustrates how the same type of ‘soft’ intangibles information changes as it progresses through analyst information intermediation processes. The latter concern: company disclosure; analyst acquisition and analysis of company information; analyst reporting processes; and market impacts. The common information concerns ‘soft’ or qualitative information about the company intellectual capital (IC) or intangibles in the company business model. Banks and bank analysts are used as examples. Knowledge, social and economic factors in the wider ‘market for information’ (MFI) are shown to be major influences on ‘soft information’ and how it changes in analyst information intermediation processes. Negative knowledge and social factors play a role in weakening and eventually destabilising economic processes in analyst and the MFI. They were important factors in creating knowledge and information problems in analysts and the MFI, both ongoing, and during the crisis of 2007-09. These factors are also part of a solution to the problems. The solutions include improved, transparent knowledge of business models of companies, analysts, and rest of MFI. They also include active use of social forces to create critical and reflexive performativity conditions in the MFI. The empirical analysis is discussed in a novel theoretical literature. This leads to improvements in a theoretical narrative which uses network concepts, ‘community of practice’, intellectual capital, organisational and social systems theory, ‘performativity’, habitus, and cultural capital. This conceptual framework for the MFI is a means to analyse knowledge and social problems in the MFI and in actors such as analysts in more coherent manner. For example, it used to argue for the development of a more critical and reflexive ‘performativity’ for the role of knowledge and information to further reduce problems in the financial system and to improve social and regulatory control over this important economic activity.
2. Theory and literature review
There are three areas and three uses of the literature and theory in this review. The literature notes that information on intangibles is likely to be important for company management, sell side analysts, fund managers (FMs) and others. The literature also explores analyst information production and disclosure and reveals that there has been little research on analyst private information processes. Finally the paper uses a range of relevant literature and theory to develop a comprehensive theory base and explanatory setting to interpret and criticise the empirical findings on analysts and their information intermediation roles in the market for information
Firstly we can note that various literature sources suggest that information on knowledge intensive intangibles (or intellectual capital (IC) is likely to be important for company management, sell side analysts, FMs and others. Both managers and analysts are interested in the role of intangibles in value creation and hence in the value of the company. Previous literature has shown that intangibles are important bsources of competitive advantage for business firms in most industries (García-Ayuso, 2003). Holland (2011) points out that tangibles provided an architecture which determined in part the nature and structure of intangibles. Some tangibles such as technology could alter the need for intangibles such as customer satisfaction or brands. Intangibles typically exploit the tangibles in value creation (Holland, 2011). From a resource-based view, competitive advantage is a result of employing strategic resources to the sustainable benefit of a company (Kristandl and Bontis, 2007), and such resources could be intangibles and tangibles. The RBV further suggests that the integration of different firm resources (tangible and intangible) is more likely to contribute to firm superior performance (Reed et al., 2006). Teece et al. (1997) stress that a firm can maintain a dynamic advantage by learning and adapting knowledge based intangibles over time.
2.1 Literature on analysts and information The second approach to the literature uses it to discuss what is known about analyst information production and disclosure. A considerable body of literature has investigated the role of analysts and other market actors in the production and use of information, and the impact of on capital markets. This has included analyst use of company supplied information (including on intangibles) and other information sources. These studies can be divided into two related groups, those dealing with analyst public information disclosures, and those dealing with analyst private information production.
Analyst public information production There is a large body of research, which focuses on analyst public information disclosures. This places much emphasis on the use of ‘hard’ or numerical information sources such as company financial statements, growth changes and market share in creating analyst numerical estimates and advice outputs. Various surveys and analyses of analyst reports reveal insights into their contents. These include studies by; Govindarajan (1980), Previts et al (1994), Roger and Grant (1997), Breton and Taffler (2001), Abdolmohamnadi et al 2006, Garcia Meca and Martinez 2007, Barker and Iman 2008, Coram et al 2011, Sidhu and Tan 2011, Arand and Kerl 2012. Many market based research studies have found that analyst’s earnings forecasts and other financial disclosures such as their buy/hold/sell recommendations are value relevant to investors (Healy and Palepu, 2001). These authors also note evidence of analyst bias in forecasting and when making recommendations, but that analysts also play a valuable role in improving market efficiency. Healy and Palepu (2001) notes that ‘there remain important gaps in our knowledge about the incentives of auditors and intermediaries (such as analysts), and the impact on their credibility.’
Some studies have revealed how ‘soft’or qualitative information sources are used with numerical or ‘hard’ information sources in creating analyst numerical and advice outputs. Many content based studies have found that analysts provide more good news in their public reports to support their recommendations for ‘buys’, and that non accounting information dominates accounting information in their reports (Breton and Taffler (2001), Barker and Iman 2008). Campbell and Slack (2008) explore the usefulness and materiality of annual report narrative disclosure in the UK, with particular reference to the banking sector. They observe that the narrative parts of annual reports that normally contain information about banks’ intangibles tend to be relatively unimportant to sell side financial analysts. This paper argues that both company management and analysts face significant problems when disclosing information about intangibles in their public reports. However, they both make extensive use of such information in their private information production and decision processes (Chen et al 2014), and in their private disclosure activities.
Analyst private information production and ‘soft’ information The above research on analyst’s public information production has not explicitly investigated how the private information process of analysts was based on private and ‘soft’ information about company intangibles, and how these combined to create the capability to prepare private and public reports, fundamental or recurrent. However, there are a small number of studies on private information production by analysts (sell side) and fund managers (buy side analysts) as in Holland and Doran (1998), Arvidsson, S. (2003), Holland (2006), Henningsson, 2009, Holland et al (2012). Holland’s (2006) study provides evidence of the importance of intangibles information to capital market actors. He finds that fund managers and their ‘buy side’ financial analysts faced major problems in their information production and investment decisions because of the increasing importance of company intangibles to share price, and the limitations of public information. They used private meetings with company management to obtain ‘soft’ information about intangibles and to understand the dynamic connections between intangible variables in the value creation process or their business model. This ‘soft’ information was used with ‘hard’ information in private earning forecasts and valuation and in public investment decisions. Holland et al (2012) revealed how privately sourced company IC information contributed to earnings estimates and company valuation by fund managers and their buy side analysts. Emotional information about intangibles (such as top management quality) contributed to fund managers and their buy side analyst’s feelings and confidence in their information use and valuation. Shared fund manager and analyst knowledge (own IC about the target firm, about own analytic skills and methods) was an important component of the key interacting and informed contexts used by these financial actors to make collective sense of these different but complementary types of information in knowledge creation. This generated opportunities to improve their internal information production in the form of an (longer term) explanatory narrative and fundamental analysis of how the companies created value. It improved their more immediate forecasts, numeric estimates, and valuations of companies and their use in ongoing investment decisions. It improved their external information exchange, disclosure and accountability activities with external sell side analysts and companies.
Research by Abhayawansa, and Abeysekera, 2009; Abhayawansa and Guthrie, 2012; Campbell and Slack, (2008) focuses on ‘soft’ intangible information in analyst reports. Abhayawansa and Abeysekera (2009) investigate intellectual capital (IC) disclosure by sell-side analysts. They noted that IC information disclosed by analysts cannot be taken at face value. They argue that issues of signalling, analysts’ incentives/influences, political economy view and globalisation have to be employed to explain IC disclosure in sell-side analysts’ reports. Abhayawansa and Guthrie (2012: 398) develop these ideas further using an “impression management” frame. Noting conflicting interests facing analysts and the relative amenability of company intellectual capital (IC) information, they find that analysts used (company related) intangibles or IC information to manage perceptions. Analysts used company IC information to “subdue the pessimism associated with an unfavourable recommendation, increase credibility of favourable recommendations and distinguish sell from hold recommendations” (Abhayawansa and Guthrie, 2012: 398).
Relationship between company and analyst disclosure The relationship between corporate disclosure and analyst disclosure has been partially investigated in various studies. Authors such as Rogers and Grant (1997) have researched the relationships between corporate public reports and analysts public reports. They explored the degree to which analysts copied information from the company’s annual report into their own analyst reports and the value added impact of such behaviour. Arvidsson (2003) also compared analyst reports with corporate annual reports and notes that both parties focus their disclosures of information on intangibles concerning company R&D and different company relations. Analysts rely on corporate disclosure and a limited sample of field based studies have investigated how companies reported information on intangibles in their corporate value creation processes (e.g., Beattie and Thomson, 2010; Holland, 2005, 2009; Johanson et al., 2001). Chen et al (2014) illustrate how banks produced and disclosed information on intangibles to market actors such as analysts. Abdolmohammidi et al (2006) find that analysts tracking high intangibles firms report higher proportions of non financial data and lower proportions of financial data compared those analysts reporting on low intangible firms.
Aims of the empirical research
The conventional analyst studies hint at the potential connections between the corporate information set, analyst’s private information, and analyst’s public information set. This studies aims to clarify these connections, and hence provide novel insights into analyst information intermediation and their public advice and reports.
This paper moves ‘upstream’ of the (market) value relevant agenda and the public report content agenda of conventional analyst research. It explores the information and knowledge processes before public disclosure in analyst reports. The aim is to provide more understanding of these prior processes and hence the information intermediation model or role of analysts in the market setting.
More specifically, the paper extends previous research by investigating the relationships between corporate private information and analyst’s private and public information production. The focus is on ‘soft’ information about intangibles in corporate value creation processes. Bank analysts and banks are used as examples. The paper also investigates how these analyst information (production, use and reporting) activities reflect knowledge of company business models (IIRC, 2011) and knowledge intensive intangibles within the analyst processes.
Finally, the paper explores how analyst information production and use reflects economic and social processes and associated logics derived in part from the ‘market for information’ made up of actors such as companies, analysts, fund managers and others. The paper investigates how improvements in knowledge of and understanding of company business models and analyst intermediation models in financial markets can potentially reduce systemic risk possibilities and increase opportunities for critical reflection on the role of such markets and market actor’s such as analysts.
Each of these areas are important their own right. Together they may also provide a stronger explanatory context for ‘downstream’ research on the content of analyst reports and on the market impact of analysts.
2.2 Developing a theoretical setting for the paper
The above analyst literature has a strong emphasis on analyst quantitative outputs. This paper seeks to explore the full information intermediation process with an emphasis on ‘soft’ information. This paper also argues that an additional problem lies in the lack of relevant conceptual framework to interpret empirical findings about analysts in the broader context of the ‘market for information’ and associated social forces.
The theoretical aim of the paper is to expand the theoretical frame to create a new means to interpret and criticise the empirical findings on analysts and their information intermediation roles in the market for information. This also is intended to create new ways to interpret the roles of many other information market firms (IMFs) (including analysts, fund managers, media, auditors, rating agencies and others) in the ‘market for information’ (MFI). Thus the third approach to the literature uses a range of relevant literature and theory to develop a comprehensive theory frame to place analyst information intermediation processes in a wider explanatory context.
The conceptual frame locates the analyst specialist information intermediation process within the ‘market for information’ (MFI). Literature on markets, ‘networks’, ‘community of practice’, habitus, and cultural capital, by authors such as Latour (1993), Luhman (1995), Fuchs (2001), Bordieu (1990), is used to develop theoretical insights into MFI structures, processes, and states. More specifically, the conceptual frame is used to briefly explain the network and market structure of the MFI and its information production and knowledge use processes. It is used to explore various states (knowledge, confidence, consensus) arising in the MFI. The MFI theoretical context places the analyst’s specialist information intermediary role in a wider social context. The analyst information intermediation function is an important part of the MFI structure, process and states. It contributes to market structure, processes and states and is influenced by them. Analyst information production and use is part of a larger MFI process. Analyst relations with companies, with fund manager clients, and other information producers and users are important parts of the MFI social network. This theoretical context is used to interpret the information intermediation roles of analysts (research, production, and reporting) operating at the heart of this market. The role of company reporting and FM research is also related to the analyst’s role in the MFI. The paper provides an empirical and theoretical example of how to explore other information intermediaries in the MFI such as the financial media, rating agencies and auditors.
The paper uses the conceptual frame to explain the nature of knowledge and social forces in analysts and the MFI. It explains how the knowledge and social forces play a role in influencing economic processes in the wider MFI, and in the analyst information intermediation process.
Knowledge was a central factor in the functioning of analysts and the MFI. For example, individual analyst’s knowledge concerned internal analyst IC concerning analyst decision processes, skills, and transactions. It concerned parent firm IC about the investment bank business model, hierarchy, culture, incentives, and training. It included external analyst IC about company business models and needs, and about models of users (client investor) decisions and their information needs. It included knowledge of links between these actors and their models, all set in wider finance networks. It included analyst IC about financial markets and how to communicate to, influence, and exploit them.
The MFI social context refers to various social factors and ‘forces’ operating in a social networks context and their influence on analysts. The social factors and ‘forces’ include norms of behaviour and a culture of secrecy in the MFI. They include understanding, consensus states and confidence states in the MFI. Key MFI based factors include the perceived reputation and credibility of company management and analysts as information sources. Knowledge is a key dimension of the MFI social context. It includes collective stories and shared knowledge both tacit and explicit. It includes collective ‘social blindness’ in the form of conservative and dogmatic views of knowledge and how to use knowledge. Performativity pressures or pressures to only think and operate within ‘established knowledge’ also exist. Sub sets of the social networks are important. These include analyst relations in networks, with companies, other analysts, other information market firms, and with clients such as FMs. The quality of relation impacts on the quality of information flows in external acquisition from companies, internal analyst processing, and external reporting to clients. High quality information exchanges are expected with high quality relations. The latter would include stable and regular interactions, and high states of confidence, trust, reputation, shared assumptions of behaviour and shared knowledge (eg about IC in company business model) between the parties. The internal social context of the analyst’s parent firm is an important source of social forces for individual analyst. These include the nature of the hierarchy or organisation, organisation process, and firm wide knowledge. It includes external analyst firm factors such as reputation, culture, and power. The analyst own skills, capability, reputation are important contextual factors in the information intermediation process.
The paper reveals how the MFI social context and social forces and associated knowledge, the related relations factors, the internal social context of analysts parent firm, and individual analyst characteristics all influence information flows in the analyst intermediation and the observed changes in ’soft’ information. Analysts are not passive in the face of these influences. They exert counter influence over the external world. Analysts conduct their behaviour and actions as part of ‘impression management’ in their ‘relations’ context, in the wider MFI social network context, and inside their own parent firm. They seek to maintain reputation and credibility in ‘relations’ and wider MFI social context, and in their own firm.
The paper use the conceptual framework to explore how these knowledge and social forces play a role in analyst’s changing use of ‘soft’ information during information intermediation. It provides a more complete means to explain the forces operating on analysts when acquiring information via company relations, during internal analyst information production within an investment bank parent, and when disclosing ‘soft’ information via private client relations or public channels. This section of the conceptual frame uses literature on social forces, on intellectual capital (IC), on knowledge exchange and use in social systems, and on the use of knowledge in information production. Authors such as Johanson (2001), Henningsson (2009), Mackenzie (2006), Meusberger (2009), Knorr Cetina and Bruegger (2002) are major sources.
The conceptual frame based on this literature and theory is used to develop a ‘theoretical narrative’ (Locke, 2001) to enhance understanding of the empirical phenomena concerning information production by analysts in the MFI. The combination of established finance theory and a broader social and knowledge based literature creates a more complete conceptual frame to interpret empirical results and explore issues in the MFI concerning analysts and companies as well as the wider market. The conceptual frame is also the basis to develop a critical and reflexive ‘performativity’ concerning analysts’ decisions and information flows in the MFI. This provides a novel theory base and explanatory setting to interpret and criticise the empirical findings on analysts, their knowledge, and their information roles. This illustrates how a novel theory frame can be applied in more complete way to interpret and propose change in finance phenomena such as the MFI and the role of analysts and other information market firms.
3. Methodology
The full detail of the research method was discussed in Chen et al (2014). Given the research purpose of investigating the role of (information about) intangibles in the bank business model, and in analyst information intermediation processes, analysts and senior managers in banks were targeted for interviews. The fieldwork was undertaken between June 2008 and September 2009, during which time the global financial crisis occurred. It should be noted that, although the financial crisis created difficulties in accessing the targeted interviewees, it was helpful to the research because analysts and managers could reflect on how intangibles played a role in bank performance and value under quite different circumstances. Analysts could reflect on how information on bank intangibles played a role in their research, analysis and reporting activities. This stimulated ‘theoretical sensitivity’ and the search for variation in core concepts. Twelve interviews with bank analysts and eleven interviews with senior managers in financial institutions were conducted. With the interviewees’ permission, eighteen interviews were audio-recorded and then transcribed carefully in order to provide a basis for reliable data analysis.
The core questions concerned - Why and how did company IC information change in the analyst intermediation process? And what was the role of knowledge, social and economic forces in the information change process? The interview questions were designed to be semi-structured in order to encourage participants to talk freely and openly about their opinions and experience.
After each interview, the researchers reviewed the interview process, and revised the interview guides based on gained information. Notes were taken by the researchers during each interview, regardless of whether it was recorded or not. The transcripts or notes of the interviews were sent back to the participants to get their feedback and to check the accuracy of the data. The interview data was processed by adopting a grounded theory method, using “a systematic set of procedures to develop and inductively derive grounded theory about a phenomenon” (Strauss and Corbin, 1998: 24). Combining this technique with a case study has the potential to strengthen case analysis by searching for patterns through cross-case analysis (Parker and Roffey, 1997). Moreover, the clearly specified operational procedures of grounded theory data analysis can enhance construct validity of a qualitative study (Pandit, 1996). The outcome of this process was a ‘grounded theory’ of banks and a similar structured insight into how analyst information intermediation processes operated. The former has been reported in Chen et al (2014). Both elements provide empirical insights in this paper on analysts.
4. Empirical insights on the information intermediation role of analysts
Sections 4, 5 and 6 of the paper explore the information intermediation role of analysts through their company research activities (Section 4), their internal analysis and information production processes (Section 5),, and their external reporting and advisory activities (Section 6). Investigating how the same type of information changes from analyst research, analysis, and reporting provides a novel insight into the analyst information intermediation model. Research on this model is a response to Lo’s (2012) view that a significant problem in the analyst literature is a lack of knowledge about what analysts do. This research is conducted through a study of how company information is changed into private analyst information, and how this contributes to analyst advice and public reports. The section of paper does this by seeking to answer five connected questions Why is the analyst’s private information similar to company management information set? Section 4. Why is the analyst’s private information different to company management information set? Section 5. Why is the analyst’s publicly disclosed information different to its private information set? Section 6. Why is the analyst’s privately disclosed information different to its public disclosure information set? Section 6. What was the role of knowledge, social and economic forces in the information change process? (Sections 4,5,6)
Field research revealed that analyst and company information sources were similar (‘mirror images’) because of their common interest in and knowledge of the company business model (Section 4). Analysts and company management both needed to understand the broad value drivers in the company for their core decisions. Analyst private information was different from company information (a ‘shadow’ of) because of differences in analyst tasks and management tasks and in firm contexts (Section 5). The specialist analyst valuation task drove such differences. Analyst public information (as narrative text or ‘soft’ information) was very limited (Section 6). Analyst private information disclosure (as narrative text or ‘soft’ information) was much richer than their public disclosure. These differences in analyst’s private and public disclosure arose because of differing impacts of knowledge, social and market factors in private and public domains, and the need to satisfy user information requirements in different ways in these domains. Feedback from users and their changing information requirements also influenced analyst private information production. Analyst public disclosure partially reflected a ‘shadow’ of the analyst private information and company information. Analyst private disclosure to privileged clients more fully reflected analyst private information and company information.
4.1 Analyst acquisition of ‘soft’ information from companies
The research question asked in this section was ;
Why is the analyst private information similar to the company management information set?
Bank analysts were interested in information about company (bank) value creation and how this led to stock market value for the company. However, the sell side analysts faced major problems of ignorance and uncertainty in their research, information production and advisory roles concerning listed companies. These problems arose due to factors operating both in the companies and analysts. The idiosyncratic nature of intangibles or the way in which company value relevant intangibles changed with circumstances, time and learning (Catasus et al 2007, Cuganesan, 2005) created problems of definition, measurement and public reporting for both management and analysts. These limited the role of corporate disclosures and other public domain information sources concerning the role of intangibles in corporate value creation. They increased problems of measurement and definition in the (increasing) intellectual capital and intangibles component to company value creation and share prices. The latter problems affected both company management and analysts in their specialist tasks. Analyst did not believe that the market was full form or strong form efficient. They perceived a significant information gap between semi strong form and strong form efficiency.
As a result, analysts sought to develop unique skills in processing both private and public sources of information (Keane, 1983). Analysts had strong incentives (and the means) to acquire current information from companies such as banks and to learn over time how their business models developed. Sell side analysts researched company public reports and other public sources. Sell side analysts also privately met or contacted senior management teams on a regular basis to discuss concrete and intangible sources of value. The paper illustrates how the sell side analysts sought to identify the many qualitative and intangible (IC based) components to the corporate (bank) value creation process (also see Holland et al 2012). They used private meetings with company (bank) management to obtain information about intangibles and to understand the dynamic connections between combinations of intangibles (and tangibles) in the value creation process.
Over time the analyst observed these business models in action and learnt how they functioned and produced value (or not). The case sell side analysts established conceptual and time based links between the many components of these models. Thus they created their own version or understanding of the dynamics of the company (bank) business model. The private interactions and information were combined with public sources to create learning opportunities. These in turn helped sell side analysts create a knowledge and competence advantage within their immediate task area and in their wider financial firm context. The size of the analyst’s investment bank parent and its resources were factors in whether such analyst knowledge advantages could be further enhanced.
The above research behaviour of sell side analysts and their private interactions were similar to fund managers and their buy side analysts in Holland (2006). Holland’s (2006) study provides evidence of the importance of intangibles or IC based information to similar capital market actors.
The direct contact with companies (such as banks), close working relationships with company top management, and the nature of the analysts’ tasks meant that the economic logic of analysts and the companies they analysed were intimately connected. Economic processes in analysts as information producers and users were closely linked to and modelled on (information about) economic processes in the companies being analysed. This meant that their information sets for decision making were similar and linked to each other.
The quality of analyst relations with company top management affected analyst access to company information. High quality relations encouraged similarities in information sources. The analyst’s 1:1 meetings with company management, based on trusting and stable relations were important means for exchange of information between both parties and for analysts to respond to measurement issues. Analyst reports and analysis, opinions, forecasts, and recommendations were discussed with management. Management discussed with trusted analysts how their business model and their strategy in competitive market were working. Analysts needed to have good reputation, a good track record for analysis and co-operation for company management to be willing to exchange ideas with them. They needed to invest in relations over time (Fogarty & Rogers 2005) to ensure that the private exchange of views and information continued and was fruitful. This is especially the case if the company has developed new knowledge intensive but opaque intangibles at the heart of their business model. The latter occurred in banks in the past decades (Holland, 2010).
Market for information (MFI) contextual factors also influenced the information exchanges and hence analyst and company information similarities. These MFI social factors occurred in the form of positive market sentiment towards a company by many actors in the social network (made up of multiple relations between companies and analysts, and others). They also occurred as reputation and credibility factors for company top management and analysts as information sources.
The company value creation process involved the complex transformation of many tangible or real resources as well as knowledge and financial resources into products and sales with desired margins in competitive real markets. In this case of banks this involved the economic transformation of deposits into payment services and loans (Chen et al 2014). This was the source of value and hence stock market valuation of a company.
The analyst value creation process involved the use of analyst knowledge, technology resources and financial resources to transform data and information about companies (and their value creation processes) into information (analysis, forecasts, valuation) and advice for investment action (recommendations).
The above illustrates that knowledge in companies, analysts and other market actors had a strong complementary nature or two-way and multilateral dependency. Both companies and information market actors such as analysts needed to understand their own and their ‘information counterparty’ economic processes. Such knowledge was required so that both parties could manage their own internal economic processes and also agree on their common information supply-demand agenda.
Thus companies and their value creation processes and valuation were the focus of the analyst’s task of information production and hence the analyst’s own value creation process. Private information production and analysis by analysts was heavily dependant on the companies they analysed and sought to understand. As a result analyst’s private information set was, in part; structured around the idea of the company business model, around idea of IC, around ideas of interactions between IC and intangibles, around accounting rules and reporting rules (Holland et al 2012). It was a ‘mirror’ of company information production. It had the same elements, and same structure or form, but different focus, content and substance.
4.2 Empirical insights into similarities between analyst and company information sets
Analysts and bank top management were both seeking to understand bank value creation and value. They faced major problems because intangibles employed in bank value creation were subjective, socially constructed, and measuring them quantitatively was difficult. Both analysts and managers focussed on information concerning the company business model and its value creation effectiveness in the immediate competitive environment and in a changing wider economic environment. The analysts sought insights and information (forward looking signals) that indicated incremental changes in the company business model or value creation processes, earnings, cash flows and value.
The analyst’s research and information production agenda was structured, in part, by the company business model, and potential changes in this. The grounded theory of banks (Chen et al 2014) illustrates key features of bank business models and their functioning. This in turn, provides insight into the structure of analyst’s research and information production and how similar it is to company management information. (See bank grounded theory summary in Chen et al 2014). The business model and analyst information categories (for research and production) thus included;
• Environmental changes • Changes in the economic environment, in the industry, in regulatory setting • Interactions • Analysts sought to understand value creation interactions in the bank business model, how intangibles interacted with each other and tangibles, and how this led to better bank performance • Consequences • Related to bank performance and to information disclosure in the external market
4.3 Environmental changes
Changes in the economic environment - causal conditions
Almost all the interviewees, both analysts and managers, discussed how the changes in economic environment influenced the role of intangibles in the banks. Ongoing economic change, especially the world financial crisis in 2007-2009, not only influenced financial institution strategies’ in making use of the interactions among intangibles, but also changed market perception with respect to understanding intangibles in the banking sector.
The customer relationship was argued to be a core intangible element for many case banks. During the financial crisis, it became even more important. Failing banks in the crisis faced problems with depositors scrambling to withdraw their funds or refusing to renew their maturing deposits (Caprio and Honohan, 2010). In this situation, the intangible of customer relationships was extremely critical for financial institutions in terms of maintaining and further increasing customer deposits. As a result, more analyst effort was put into understanding the interactions among critical intangibles and their impacts on lending and borrowing activities, as well as risk management during the financial crisis.
Analysts’ recognised that the financial crisis changed the market perception on intangibles, but the picture of influences tended to be a mixed one among bank analysts, reflecting variation in analysts quantitative and qualitative ‘styles’. Some analysts (A4, A5, A8, A9, A11, and A12) perceived that the financial crisis drew public attention to some important intangible elements, such as brands and customer relationships. Others, however, argued that intangibles became less important in the financial crisis (A3, A6, A7, and A10).
Analysts A4, A8, A11, and A12 emphasized the importance of brand power in the financial crisis.
Analyst A8 argued,
“So you know, certain banks have built the reputation around their name,…they have a name which has become actually quite trusted from the consumer perspective. So in this environment, having that intangible on the brand has been very very valuable indeed.”
(Interview A8)
Analyst A5 stated that the financial crisis made customer relationships more important than before.
“[N]ow when all the consumers and general public are very nervous about their bank, I think it becomes more important than ever that you have a strong customer franchise. You’ve seen what happened to some of the smaller banks which have weak customer franchise and weak balance sheet [and] have to be nationalized.” (Interview A5)
It can be seen from the above discussions that the financial crisis has changed analyst, FM and wider public perception regarding intangibles. More analyst attention was placed on some intangible elements than before. More importance was placed on tangibles.
However, some other analysts expressed a contrary view with this. Analyst A10 argued that brands and customer relationships became less important in the crisis, and whether or not a bank could survive was the most important thing. Analyst A6 held a similar opinion. He pointed out that the only thing that matters during the crisis was how much capital a bank had.
Analyst A7 explained more clearly,
“[W]hen you need capital, you need something you can sell easily. So I guess intangibles would be something that would be discounted much more heavily than anything else. So I mean, in practice, for our valuation right now, we completely ignore intangibles. At least I tend to ignore intangibles. Maybe when the market changes to [be on] a more booming side, then people would be much more willing to give some credit for intangibles.” (Interview A7)
In summary, the majority of interviewees believed that changes in the external economic environment resulted in changes in the perception of intangibles (e.g., some specific intangibles became more or less important due to change in economic condition), and also influenced significantly the interaction process of intangibles and financial intermediation activities, although the overall view on such influences appeared to be mixed. These provided new insights and information (forward looking signals) that indicated incremental changes in the company business model or value creation processes, earnings, cash flows and value.
Changes in the banking industry – causal and contextual conditions.
Analyst had to understand how banks changed their strategies and their management of intangibles in response to the major changes they faced. Technology development has significantly changed the competitive environment in which banks operated. New technology created opportunities for them to reduce costs and deliver products and services in different channels, such as Internet banking or telephone banking.
Analyst A3 noted that for some commoditised bank products (e.g., large mortgages),
“[t]he majority of the market is run by intermediaries and receives very little trust in the banks themselves. People prefer to take independent advisors, and also with benefit that the independent advisor will select products from the entire market place rather than just a range.” (Interview A3)
The above statement shows that technology development provided more choices to customers for choosing bank products and services, and hence increased the difficulty of maintaining customer relationships for banks. Therefore, new technology offered not only opportunities but also challenges to banks. It created major challenges for banks analysts to understand bank strategic resposnse.
Industry context - contextual conditions
Information on sector conditions such as the role of brands in bank service delivery, homogeneous intermediation processes and products, role of top management, and different banking segments, were of considerable interest to the analysts.
Analyst A3 argued that brand power was important in the manufacturing industry, but tended to be less valuable in the banking sector.
“If you take, for example, cars, people will pay more for Aston Martin than they will pay for Jaguar, even though they were both by Ford and both in the same platform, purely because the brand value of Aston Martin,... However, people would not pay any more for Northern Rock mortgage than they would [pay] for Lloyds TSB mortgage, because money is an ultimately fungible factor.” (Interview A3)
Analyst A6 pointed out that banks were homogeneous in terms of them trading in a narrower P/E range than all other sectors. Therefore, top management human capital tended to be important in differentiating banks.
“Consequently, I think, because the business is quite homogeneous, this kind of perception of management is quite important for differentiating between, you know, one has been perceived to be the best bank and the worst bank at any one time.”
(Interview A6)
Business segments were contextual conditions that influenced intangibles in terms of the relative importance of different intangible elements, the interactions, and bank strategies in response to them ( A1, A2, A3, A6, and A11).
Moreover, the interactions among intangible elements or between intangibles and other types of resources and activities were likely to change along with different business segments. For instance, analyst A6 suggested that price tended to be the key factor that affected customer relationships in retail banking. However, in corporate or investment banking, customer choices could be affected by reputation.
“When I am looking for a mortgage, I don’t care whether the bank is safe or not. I just look for the cheapest rate. Now I am sure if you are dealing with some sophisticated structured products…, then the reputation of the bank is on the line, and the reputation of the company is on the line. You will pay more to have Goldman Sachs advising,…just because you want their name,…” (Interview A6)
The analyst case data also shows that the external regulatory climate appeared to be one of the important conditional features that bore upon the role of intangibles. Analyst A10 noted that under the recent accounting changes, banks could now assign value to brands and branch offices, and she as an analyst paid attention to this as well. In addition, manager B9 argued that the influence of accounting standards and some other banking regulations could be either positive or negative in terms of affecting product innovation and design, as well as delivery channels.
4.4 Interactions
Analysts sought to understand value creation interactions in the bank business model. They sought to understand how different elements of intangibles interacted with each other, how they had impacts on tangibles, and how this led to better bank performance.
Interactions between intangibles of the same type:
For example, the following analyst quotation shows that brand strength could affect customer relationships.
“[I]nvestors would often say, ‘we like UBS and Credit Suisse, because they have private banking brand’. So people would choose to bank with them because they have the strength with their brand in private banking.” (Analyst A10)
It should be noted that brands tended to be closely related to customer relationships, and these two elements to some extent overlapped from some interviewees’ perspective. For instance, manager B8 argued that brands were usually about users' experience, while analyst A5 stated that brands could be seen as part of customer franchises.
Interactions between different types of intangibles:
The case data also reveals that a number of interactions occurred cross the four main categories, namely top management human capital, employee level human capital, structural capital, and relational capital. Interactions at this level included how top management human capital affected other types of intangibles, how employee level human capital and relational capital affected each other, and how they combined with structural capital to contribute to the value creation process.
First of all, top management human capital tended to influence all other intangibles. Consistent with this, many analyst interviewees indicated that top management quality and decision making could have direct impacts on setting bank strategy, improving engagements of lower level managers and employees, enhancing organizational culture, building and protecting brands, and so forth.
As analyst A4 argued, “the bank in nowadays is nothing without [its] manager team running it”.
Top management human capital could affect relational capital both indirectly (as mentioned by manager B10) and directly. Analyst A4 illustrated that top management who got long-term working experience across different parts of the bank could enhance customers and investors’ confidence within the bank. Similarly, analyst A8 argued that the reputation of top management was closely related to the bank’s name. As a result, the top management track record or creditability could directly affect the bank’s brand. Moreover, several interviewees used examples to show that top management decision-making could influence customer relationships with the bank, either positively or negatively (B2 and A6).
This section has shown that the integration of intangibles and tangibles rather than intangibles alone contributed to bank business success. This supports the importance of resource integration in the RBV theory. Intangibles are not just a simple sum of human capital, structural capital and relational capital. Rather, it is the sum of those three components plus the interactions among them (Carson et al., 2004) that are important.
Interactions – between intangibles, financial resources and intermediation - in the full business model
The third level of interactions involved the relationships between intangibles and tangible or financial resources, as well as financial intermediation and risk management activities. In this part of the value creation process, intangibles interacting with tangible or financial resources could improve the bank intermediation process and risk management.
Firstly, some analyst interviewees emphasized that intangibles played an important role in attracting deposits, especially in the financial crisis (A4, A7, A8, and A12).
Analyst A7 highlighted,
“Is the brand important for the bank? I would say it is extremely important. One reason why it is important is [that it represents] the ability of the bank to attract deposits. You know, the ability to attract deposits is extremely important to the bank, particularly in the current environment, where funding is one of the biggest challenges the banks face.
Therefore, it can be seen that on the liability side of the balance sheet, the interactions among intangibles and tangibles could affect customer deposits. On the asset side of the balance sheet, the case institutions exploited the impacts of intangibles on loans and other products selling as well. Human capital and structural capital such as lending skills and knowledge of lending processes effected loan profitability and their risks.
Other relational capital elements such as the brand could also directly influence lending.
Analyst A11 noted,
“On the asset side of the balance sheet, you know, there may be some brand value. So for example, if you were looking for mortgage in the UK, you might phone up Halifax because you heard their brand….You may not phone up the number of other institutions that provide mortgages, because you haven’t heard their brands. So there is possibly some value there.” (Interview A11)
With regard to the cost control, some previous studies provided evidence that relational capital have the ability to lower costs. For example, Storbacka et al. (1994) demonstrate that the cost of obtaining a new customer normally exceeds the cost of retaining an existing customer. The importance of intangibles in helping banks reduce costs was also mentioned by managers and analysts (B1, B2, B6, B8, A2, A6, and A11).
Finally, intangibles were argued to be important in affecting risk management. Tonkiss (2009) argues that the financial crisis in 2007 illustrated that markets failed in their tasks of managing and distributing risk, and it involved a massive failure of trust and confidence. Customers or investors trust and confidence were indeed their emotional capital for financial institutions, which could be treated as part of intangibles and could have a significant impact on risk control. Once customers or investors lost their trust and confidence with a bank, deposits withdrawal risk tended to increase and this posed a significant threat to the bank’s survival.
Holland (2010) points out that the knowledge problems with intermediation and risk at the board of directors and top management level tended to be one of the major factors that caused the bank failure and was deeply implicated in the crisis. The knowledge about intermediation activities and risk management that top management learnt from the market change and their experiences was an important intangible for the financial institutions.
Analyst A6 noted,
“So actually the management in terms of how [they] embody the cost control culture, how rapidly they want to grow the balance sheet, how risky they want to be with the balance sheet in terms of leverage, is by far away the most important thing.”
This is in line with Holland’s (2010) argument that the board of directors and top management in failing banks prioritised their knowledge of general business strategy over knowledge of organization, risk, intermediation and special function in banking.
Apart from top management human capital, some other types of intangibles could also affect risk management. Previous literature shows that customer relationships can help firms transfer information and knowledge, and then provide opportunities for firms to create innovative products and increase sales (e.g., Reed et al., 2009; Gibbert et al., 2001). In banking these linked intangibles when driven by the profit motive alone can increase bank risks (Holland, 2010).
The case evidence presented above illustrates how analysts sought to understand how intangibles impacted tangibles, and supported the two-way relationship between them. Analysts perceived that tangibles acted as the hygiene factors and provided the foundation for the bank business model to work. Analysts perceived that intangibles interacted with tangible and financial resources during the process of internal interactions, and influenced financial intermediation activities and risk management.
4.5 Consequences
The case analysts sought to understand how the consequences of interactions were related to both bank performance and information disclosure in the external market. As noted previously the interactions of intangible strengths and other types of resources could lead to the increase in deposits or loans and the reduction in cost and risk, and these could result in better institution performance.
Improved performance could come from individual intangible strengths or the interactions of different resources.
Analyst A1 noted that different management skills were key drivers to excess returns.
“People are willing to believe you can make excess returns in this area, you must be, because you have skills, risk management skills such as Barclays claims to have; or marketing skills, such as Capital One claims to have; or would be efficiency skills, you know, Bank of America will say they are very efficient, because they are big. So they can generate excess returns through having the same revenues as anyone else but because of the cost base.” (Interview A1)
Additionally, changes in top management human capital could have a direct impact on institutions’ share prices. Analyst A5 mentioned that the change of CEO normally caused the institution’s stock price to go up or down, depending on the market conditions. Analyst A6 and A10 also pointed out that the institution’s share price would change significantly when there were major changes in the top management team. This argument is consistent with prior literature that provided empirical evidence on the market reaction to organizations’ top management change (e.g., Beatty and Zajac, 1987; Warner et al., 1988). For example, for a sample of 209 large corporations from 1979 to 1980, Beatty and Zajac (1987) find that announcements of CEO changes are typically associated with a reduction in the firm value. Many interviewees expressed the similar view that the combined effects of different intangible resources and other types of resources were more important than individual intangible strengths (eg A12). Analyst A12 stated that a bank’s brand strength, financial strength, and strengths of reputation or management quality related to its share price. Similar views were observed with analyst A6. “I think it is very difficult to differentiate [banks] just based on one of that elements [intangibles], to say yeah, this bank’s performance is better than that banks’ because its recruitment policy has been better. I think it is very hard to do that. So you would just assume that the management [who] pays most attention to recruitment is probably going to be the one that does all the other things right as well.” (Interview A6)
5. Analyst private processing of‘soft’information.
The research question asked in this section was;
Why is the analyst private information different to company management information set?
5.1 What the differences were.
Differences were noted in the analysts private information set compared to the company information set.
The empirical results showed that the managers and analysts interviewed had different views on general ideas related to intangibles, including the definition and understanding of intangibles, the importance of intangibles to bank business success and the key intangible elements or indicators. As a result, the internal management and external observers (bank analysts) had different views on the dominant intangibles and processes outlined in bank business models. This led to different information agendas for analysts and companies concerning the business model and sources of value.
More specifically, the case data revealed differences in bank management and analyst views on intangibles and the information agenda. This concerned differences in the
• Understanding of intangibles • breadth of the intangibles ‘picture’ used • reverse and forward ways – used to explain interactions • Definition of, and perceptions of, intangibles • – as narrow financial &accounting categories vs broader human capital categories • Measurement of intangibles • Stronger preference for quantitative indicators over • qualitative information • Perceived absolute and relative importance – • of intangibles vs intangibles, intangible vs tangibles • of intangibles with major strengths – core intangibles • and how the above changes with economic circumstances • Role of combinations of intangibles – coherent, integrated?
In general, managers had a more comprehensive picture of intangibles than analysts in terms of understanding intangibles, including the definition and classification of intangibles, the importance of intangibles in the bank business model, as well as what were the core intangibles. Managers tended to define intangibles from a broader concept than analysts, as some analysts considered intangibles an accounting item on the balance sheet only. In addition, managers were more comfortable with the three categories of intangibles used in academic research, namely, human capital, structural capital and relational capital.
Information differences arose because of analyst’s specialised tasks compared to company management. The analyst ‘big picture’ or ‘mosaic’ of connected information (about the role of intangibles and tangibles in company value creation) was more narrowly focused because of the analyst need for information for valuation purposes. This task influenced their preferences for more quantitative measures and for information on a small number of company intangibles. Analyst’s information was limited by restricted access to company information, by their more focused cost-benefit calculations based on their valuation and advice tasks. Analysts sought ‘just enough’ information for these decision purposes. Analysis ‘style’ was important. ‘Mixed method’ analysts were more focussed on a smaller group of specific intangibles such as top management quality, front line employee skills, brand strengths, and customer satisfaction, and their links to performance. Quantitative analysts focused only on intangibles which could be measured in some way.
Thus major differences in analysts information needs compared to company management arose because of differences in analysts and company management decision tasks. The bank analysts paid special attention to the following company information sources and signals concerning changes in measurement of intangibles and how they related to the analyst ‘big picture’ or ‘mosaic’;
• Variation in company intangibles measurement systems – within firms, across bank segments. • Surveys of relative value ranking of intangibles • Trying to link intangibles to financial performance outcomes • --by direct observation of the impact of say top management skills on strategy implementation and on performance • --by ‘reverse attribution’ of performance to key intangibles such as brand strength • And learning how both above change over time • Observing change as – significant change – as negative change – in intangible measures – subjective and objective
These differences were contributory factors to differences between the analyst private information set and the company management information set
Managers perceived intangibles to be a broad concept that included not only the accounting number of goodwill and other intangible assets on the balance sheet but also other non-financial items, while quantitative oriented analysts appeared to focus mainly on the former when they talked about the term intangibles.
The analysts and banks differed in the way the understood the interactions in business model. The banks tended to provide forward-looking explanations of the role of intangibles in the company value creation process. Analysts looked at intangibles through a reverse attribution or inference of how financial performance (FP) was caused by the role of intangibles in the company value creation process. They then used the inferences in their forward looking view.
Almost all the managers interviewed presented the view that intangibles rather than tangibles were key sources of competitive advantage for their institutions. The analyst accepted this but placed more emphasis on financial tangibles (equity, cash) and intangibles (such as goodwill).
Almost all the managers interviewed discussed the importance of intangibles for their business success. Company (bank) management stressed intangibles and a more balanced and integrated view of a combined set of tangibles and intangibles. Some core intangibles may have been more important for value creation, but it was the combination and their purposeful integration that actually created value.
In the case of analysts, they argued for a high relative importance of tangibles compared to intangibles in the company value creation process. They focussed on a smaller set of key intangibles, their relations with financial intangibles and tangibles, and their eventual impact on value.
Analysts’ views on the importance of intangibles, differed from managers’. It is found that although analysts acknowledged the significance of intangibles in wealth creation, they prioritised tangible or financial strengths rather than intangibles in contributing to superior bank performance, especially during the financial crisis.
However, it should be pointed out that most of the analysts claimed that they did consider intangibles when they assessed a bank. Although such information could not be put in their public reports on the grounds that their reports had to be based on accurate analysis rather than personal judgements, analysts thought about intangibles privately when they made recommendations to clients.
When answering the question “what may be the important intangibles for a bank?”, the majority of analysts argued that apart from goodwill, top management HC constituted the key focus in their bank valuation.
The analyst own private information production and story about the company value creation process was based in part on company information and in part about their own sources. The analyst information set was an adapted ‘mirror image’ of the company management information set comprising the company business model and its value creation effectiveness in the immediate competitive environment and wider economic environment. It included information on how company value creation involved many purposeful and dynamic interactions between tangibles and intangibles leading to earnings and other accounting and financial numbers.
The analyst private information as a ‘mirror image’ focused on the same form, elements and interactions but had different emphases, focuses, and priorities in these relative to bank management. As a result the analyst’s private information set did not have the same substance or content as the company information set.
5.2 Analyst views on differences between analyst private and company information sets
Understanding and defining intangibles – analyst view point
Quantitative oriented bank analysts interpreted intangibles primarily as an accounting item, that is, the accounting number of goodwill and other intangible assets on the balance sheet. As analyst A1 stated, “That’s a challenging topic. I mean most people, myself and my competitors, will generally think intangibles is a line on the balance sheet, which will be acquired intangibles and goodwill, that is, when you bought a bank or asset, its premium to book value. So I think we are lazy in that we wouldn’t look at generally intangibles.”
(Interview A1)
Similar views were also observed from interviews with analysts A2, A8, A9, and A10. For example, analyst A8 stressed that the concept of intangibles to some extent was seen as an accounting issue that banks had to use after an acquisition. Analyst A10 also mentioned that, “[O]bviously for me, intangibles are largely the figures that I can see on the balance sheet, which is goodwill and acquired intangibles.” (Interview A10)
However, the ‘mixed methods’ analysts did not employ such a narrow definition about intangibles. They looked at other non-financial intangible items, which they called “soft intangibles” or “soft factors”. As analyst A2 explained, goodwill was indeed a financial measure of intangible assets.
“I think that’s, first of all, on the balance sheet of the banks, they all have intangible elements, which just come from acquisition, so therefore, which is goodwill, what we’re talking about here, that has been paid for the bank. That constitutes most of the intangibles. But that goodwill itself is a measure, [which] supposes to be a measure of the value of source of assets, intangible assets. And that includes franchise, brand value that we are mentioning, customer relationships, …and human capital [that]is also extremely important. So therefore, we do look at them in that way.” (Interview A2)
The relative importance of intangibles and tangibles in the bank business model – analysts vs management
The views on the relative importance of intangibles in the bank business model from analysts’ perspective appeared to be mixed. Firstly, several analysts had a similar view with managers, that is, intangibles were the main sources of competitive advantage (A1, A2, and A6).
Analyst A1 argued that, “banks are all about intangibles”. Analyst A6 stressed that intangibles could have long-term impacts on banks’ business success.
“I’d like to break the banks down into four basic categories:…revenue, costs, bad debts, and other. What I want to say is that the kind of management, or culture, or intangibles in a broad sense can have a short-term impact on the costs. But in the long-term, it can have an impact on everything....” (Interview A6)
He went on to say,
“So one of the things I’d like to do is to look at the change of return on assets over five years or ten years, and then to see which bank management is adding the most value. Now in the way that’s tangible, but then I have to make – you have to assume that there are intangible elements driving [it].” (Interview A6)
The above quotation shows that analyst A6 believed that intangibles were the fundamental driver of bank business success. This also shows analyst learning over time about bank intangibles. Similar view was observed from analyst A2.
“I tend to think [that] there are important differences between banks, and [these differences] do ultimately drive success or failure of a bank. These differences do come down to people – human capital, decision making and so on, and also to, in retail area, the value of franchise, distribution network, and so on.” (Interview A2)
Secondly, most of the analysts interviewed (A4, A5, A7, A8, A10, A11, and A12) stressed that although they acknowledged the significance of intangibles in wealth creation, they prioritised the tangible or financial strengths rather than intangibles in terms of creating value for banks. For example, analyst A4 mentioned that he focused on the price-to-book value when he analysed a bank. Only when banks had the same price-to-book value, did he differentiate them by taking into account other issues such as strengths of brand, management team, or culture.
Analyst A5 explained more clearly about the underlying model of bank valuation. He noted,
“I think at the moment, the most important thing is the tangible assets. You know, when I’m analysing a bank, … 95% of my time is spent on analysing the tangibles, you know, analysing the balance sheet, the quality of the assets the banks have. And then, when I am thinking about my final conclusion, I would include in my final conclusion some analyses on the intangibles. So at the moment, it’s all about the financial strength of your balance sheet. And then on the top of that, if you have a good customer franchise, a strong management team, then I think that’s a bonus, but not the biggest factor.”
(Interview A5)
Economic circumstances - research and analysis focus - and information production priorities.
The broader economic and financial circumstances in which the analysts conducted their task were important. This changed their research focus and information production priorities. This changed their relative focus on various intangibles and tangibles.For example, the ‘circumstances factor’ concerned the financial crisis during which time most of the interviews with analysts were conducted.
The case data shows that the more emphasis was placed on the tangible or financial resources compared to intangibles by most of the analysts. This is not a surprising finding as analysts were “technocratic and rules-driven in nature” (Campbell and Slack, 2008:4). At that time, capital or liquidity problem tended to be a crucial issue for the majority of the financial institutions. As a result, analysts paid more attention to banks’ financial strength of capital or liquidity.
As analyst A7 remarked,
“[T]he valuation at the moment has a tendency to be kind of pessimistic …because economy is slowing down,…Because you know, when you need capital, you need something you can sell easily. So I guess intangibles would be something that would be discounted much more heavily than anything else.” (Interview A7)
The second reason is that one of the main roles of analysts is to assess a bank’s value and develop forecasts using financial analysis. Their reports are generally based on numerical data. However, information on intangibles is largely presented in qualitative terms, and this to some extent limits the usefulness of such information in reporting.
Analyst A2 pointed out that,
“As for the other [intangible] elements, the problem is although we know they are very important, it is hard to quantify them. So when analysts look at companies, we’d like to do a lot of analyses and that tend to be based on quantitative data and broad hard data. When we talk about intangibles by its nature, it’s soft data. It’s hard to assess the value of it.” (Interview A2). Analyst A10 expressed a similar view. She said, “I am really interested in it [intangibles] if I can see a monetary issue attached with it and a way to prove it. And those are very difficult.” (Interview A10)
Apart from the above discussed views on the importance of intangibles, a few quantitative oriented analysts mainly focused on accounting number of goodwill, but paid little attention to other intangibles (A3 and A9). Analyst A3 noted that he “disregard it [intangibles] in a large part”. Analyst A9 mentioned that the impairment of intangibles (e.g., the impairment of goodwill during M&A and the impairment of IT investment) was important for bank valuation, but he tended to focus less on other types of intangibles.
Core intangibles and combinations of – difference in company management vs analyst views – hence information differences?
Company managers views:
The interview data shows that the managers in the case institutions tended to pay more attention to intangible elements in which they had relative strengths compared with peers, but at the same time emphasized the importance of the combination of different intangible components. Managers’ perception of the core intangibles appeared to vary. Some of them discussed the importance of balancing or combining different types of intangibles, and at the same time gave more weights to some intangible elements than others. Other managers emphasized the specific intangible strengths they had or the critical intangible elements in the financial crisis. Customer relationships, as a core intangible factor, were mentioned by many managers (B1, B2, B3, B4, B9, and B10). Human capital, either in top management level or employee level, was argued to be another important intangible element by manager B1, B6, B7, and B8. Managers B5, B7 and B10 highlighted the importance of brands, while manager B8 gave 295 priority to culture. It should be noted that some managers identified more than one intangible element as the core intangibles for their bank.
On the other hand, the majority of analysts argued that apart from goodwill, top management HC constituted the key focus in their bank valuation.
Analysts’ views: goodwill
With regard to analysts’ view on the core intangible items, most of them perceived that goodwill and top management human capital were the most important intangibles for banks.
The majority of analysts (A2, A3, A4, A5, A8, A9, A10, and A12) identified that goodwill on the balance sheet was the most important intangible element from valuation perspective. Goodwill, as an accounting number on the balance sheet, tended to be a significant factor in bank valuation method in which price-to-book ratio is generally used to valuate banks. In this sense, it is important to exclude goodwill in calculating book value of a bank.
As analyst A4 noted,
“For bank valuation, it is quite important from the ‘book perspective’, because bank has been valued at the moment as price to tangible book. People want to know what the tangible book is. Therefore, they take out the intangibles on the balance sheet, specifically goodwill remaining on the balance sheet,…That’s very important for bank valuation.” (Interview A4)
Additionally, goodwill is also a deduction of capital. In this sense, it became an important factor in the financial crisis, as capital appeared to be critical for banks’ survive at that time (A3, A5, A10). Analyst A3 argued that during the financial crisis, analysts and investors tended to discount all the non-capital items, such as goodwill.
It can be seen that the importance of goodwill, from analysts’ perspective, was mainly discussed as an accounting term. In this instance, it was treated as a financial metric on the balance sheet rather than as an intangible element. However, several analysts considered that it was indeed a proxy or measure of intangible assets, such as customer relationships, brands, and branch networks (A2 and A10).
As analyst A2 remarked,
“But that goodwill itself is a measure, [which] supposes to be a measure of the value of source of assets, intangible assets. And that includes franchise, brand value that we are mentioning, [and] customer relationships,...” (Interview A2)
Analysts’ views: top management l
Apart from goodwill, top management human capital was argued to be another core intangible element by most of the analysts interviewed (A1, A3, A4, A5, A6, A7, and A8).
Additionally, analyst A6 stated that top management skills could have an impact on other types of intangibles. This reflected analysts’ ideas that change in combinations of intangibles in the business model arose primarily through top management direction.
“So actually the management in terms of how [they] embody the cost control culture, how rapidly they want to grow the balance sheet, how risky they want to be with the balance sheet in terms of leverage, is by far away the most important thing. …You know, the idea from an analyst… is [that] the management will set the tone on the culture and a lot of other intangibles, and therefore they are the starting point for all of those.”
(Interview A6)
The above finding is in line with Breton and Taffler’s (2001) study. They find that apart from profit-based financial information, non-financial qualitative factors, in particular corporate management and strategy, were the most significant drivers of analyst judgement.
Although most of the analysts were favourable to the importance of top management human capital, some of them stressed that the relative importance of intangibles might vary with the different types of banking. For example, some argued that brands and customer relationships were very powerful in retail banking (A2, A7, and A10), while human capital such as professional skills and employee knowledge tended to be extremely important in wholesale and investment banking (A2). On the other hand, analyst A6 noted that the customer relationship was important in corporate banking and brands were important in investment banking, but either of them was less relevant in retail or commercial banking.
5.3 Why the differences?
These information differences arose because analysts altered the information they received from companies to match the needs of their specialised research and internal information production tasks. Analyst sought ‘just enough’ value relevant ‘soft’ information within structured analysis task sequence. They constructed a ‘mosaic’ of such information ‘pieces’ for valuation purposes. The analyst’s own parent firm culture was an important factor in influencing analyst specific knowledge and skills, their quantitative or qualitative style preferences, and their analysis routines and behaviour. These analyst firm and individual analyst factors created differences between sell-side analysts in their use of company information, as well as differences between them and company management. Analyst changes in company sourced information were also influenced by a combination of analyst social and economic factors. These included factors such as measurement issues for intangibles, company relationships as well as social network factors in the MFI, market incentives and economic circumstances. These factors meant that there were major differences in company and analyst tasks, and their social and economic contexts and associated logics. These in turn led to differences in the analyst’s private information set and the company information set concerning company intangibles and value.
More specifically the case data revealed that company (bank) sourced information was ‘adjusted’ in the analysts by the following factors.
The analyst’s own unique task, own knowledge (IC) and parent firm culture were quite distinct compared to companies.
Tasks differences between managers and analysts influenced the differences in information sets. The role of managers in a bank is to manage it, while the role of analysts is to value a bank. In this sense, the managers looked at the whole process of bank value creation that involved both financial and non-financial elements. They sought to have a comprehensive understanding of a relatively stable value creation process. Analysts sought to understand ‘just enough’ about the bank business model to identify the main value drivers and incremental change suggesting changes in performance and value outcomes. These value relevant information elements were likely to be transient when viewed within a changing analyst ‘mosaic’ of information (Holland, and Johanson, 2003).
The analyst routine task involved search, analysis, evaluation, estimation and report writing phases, all set in the (investment bank) parent firm context. This can be interpreted as goal seeking, routine process with a structured task sequence with this set in an organisational context (Cyert and March, 1963). The routine analyst processes had similar structural features to those found by Bouwman, Frishkoff, and Frishkoff, P (1987, 1995) for other sell side analysts and those found by Holland and Doran (1998) and Holland (2006), Holland et al (2012) for FMs and their buy side analysts.
More specifically, the analysts unique task involved research, analysis of each company, prediction of earnings and likely value range in periods ahead (three, six, twelve months), provide advice both public and private, and make buy, hold, sell recommendations. The analysts sought insights and information (forward looking signals) that indicated incremental changes in company value creation processes, in intangibles, earnings, cash flows and value. In this regard, Holland (2006) notes that fund managers (and their buy side analysts) when looking beyond a forecastable horizon (of say 2 to 4 years) used their knowledge advantage (about company IC intangibles) as the basis for an act of faith in judgements concerning future value arising in the company beyond this horizon. This ‘fudge’ was added to their more formal estimate of value created within the forecastable period to arrive at a fair value for the company. The fund managers were also clear that this was much more a black art than a science.
The case analysts acquired a knowledge advantage concerning the role of intangibles in the corporate value creation process through continuous interactions, observations and reflection. The analysts used their knowledge to create a ‘mosaic’ or ‘big picture’ of company value creation (Holland, 2006). Within this ‘mosaic’ analyst focussed on a partial understanding of the key intangible/tangible elements and their interactions of in the business model, as well as on incremental changes in these relevant to value changes. Analysts sought ‘just enough’ understanding and information to match their decision problems. Simon’s (1957) ideas of ‘bounded rationality’ and satisficing’ were relevant to explain such analyst ‘just enough’ decision behaviour. Each information element by itself may not be meaningful but when the pieces are fitted together in a ‘jigsaw puzzle’ they may provide new insights. The mosaic formation process can be interpreted as a process of sensemaking (Weick, 1995). According to Weick (1995), ´ Sense making is the search for contexts within (which) small details fit together and make sense… It is a continuous alteration between particulars and explanations, with each cycle giving added form and substance to the other. It is about building confidence as the particulars begin to cohere and as the explanation allows increasingly accurate deductions. (Weick, 1995, p. 133).
The analysts use their knowledge advantage to explore how the company level intangibles or IC factors (within the business model) interacted with expected changes in macro economic conditions and competitive conditions. This information on external impact and internal responsiveness was only available by combining private and public sources within the ’mosaic’ process (Holland and Doran, 1998). New information here led the analysts to alter their perceptions of the riskiness of corporate plans, the up and downside range of financial returns, the potential for major losses, and hence to alter their views of corporate valuation. The above constituted a prior analyst framing of corporate gains and losses that was similar, in some respects, to Tversky and Kahneman’s (1992) model.
The mosaic and associated analysis were the analyst means to develop their own narrative or story of company value creation to summarise much complex company based information (Holland, 2006). Holland et al (2012) noted that FMs and their buy side analyst’s view of the company could contain a broader in house narrative with explicit causal links that connected the company business model, strategy and company IC information to the competitive environment. These factors in turn could be perceived as driving earnings levels and their risk. New earnings estimates numbers were understood within such a context. Their story and understanding of changes in the business model then became the basis for analyst numerical estimates, valuation and advice in their public reports. The case bank analysts had special ways of understanding intangibles in value creation. They conducted ‘reverse attribution’ analysis linking financial performance back to key intangibles. They also externally observed and learned over time about business model interactions (in many similar firms). These processes affected their information search, production and content, and their subsequent forward looking view.
The central role of the analyst’s valuation task meant they sought insights and information (forward looking signals) that indicated incremental changes in company value creation processes, earnings, cash flows and value. These ‘just enough’ incremental information sources were interpreted within the ‘big picture’ or mosaic of company value creation. The company business model and IC information were primarily used to enhance immediate and short term analyst forecasts, valuation and advice decisions. They were also used to develop a long term understanding of the company business model and thus analysts understanding and confidence in the longer sustainability and risks of corporate performance. This could provide insight into the ability of the company to maintain its levels of, and risks, of its longer term earnings and value creation relative to peer groups and the market, and thus improve estimation of company betas (Thomas, 2003)
The analyst’s own parent firm culture was an important factor in influencing their knowledge and skills, their quantitative or qualitative preferences, their analysis routines and behaviour. This parent firm, often an investment bank, and its culture, were often quite distinct compared to companies and other financial firms. The parent culture influenced analysts’ incentives, motives for information research, production and disclosure. Differences between financial firm cultures (Schein, 1989) has been identified as a cause of communication difficulties between them and the wider market (Holland and Johanson, 2003; Henningsson, 2009). This includes difference between investment bank parents of analysts creating different emphases on quantitative versus ‘mixed methods’ research and analysis. This context could also influence analyst behaviour such as (investment bank) firm wide influences on analyst bias and analyst optimism in information production and internal use. Analyst’s parent firms (IBs) also varied in their size, reputation, perceived power as well in financial resources and knowledge management resources. These factors influenced the parent firm capability to support analyst learning, internal knowledge exchange, and the development of individual analyst skills, and shared knowledge about company models.
The above indicates that further variations in company and analyst use of company intangibles information arose due to variation in analyst ‘type’ from strongly quantitative oriented, to qualitative to ‘mixed methods’ analysts. The more quantitative the analyst the more they used balance sheet and profit and loss data in their analysis, the more they focussed on finance intangibles such as goodwill, and the less they focussed on information on knowledge based or ‘soft’ bank intangibles. In contrast, ‘mixed method’ analysts used a mixture of qualitative and quantitative information sources (on company intangibles) for their private analysis but used a lower qualitative component in their external reporting. The ‘mixed method’ analysts formed the bulk of the analysts. The differences in epistemology meant the analysts varied in their ‘bounded rationality’ and satisficing’ (Simon, 1957) and they varied in what they thought was ‘just enough’ understanding and information about company intangibles. These variations in individuals could also arise from investment bank parent philosophy, practice and culture.
The analyst’s own knowledge (IC) was quite distinct compared to company management and analysts in other financial firms. Each analyst had their own personal knowledge, skills and capabilities, personal preferences for qualitative and quantitative information, as well as the ability to exploit the knowledge and competences within the analyst’s investment banking parent. They had special skills in gaining incremental information about companies in their competitive environment and in developing their own narrative about the company business model. This could be through analysis of company accounts or through cross company comparison (Holland et al 2012). As in Holland et al (2012) prior analysts theory of stock market behaviour, use of information and pricing were used to interpret current market conditions, whether the market had the same information as the analysts, how analysts information would change stock prices, and when the market was likely to find this information. The analysts sought to find new ways of adding to this knowledge based competitive advantage, and to boost and protect their reputation in these areas. These variations could also arise from investment bank parent philosophy, practice and culture.
Intangibles were more intangible for analysts than company management. The idiosyncratic nature of intangibles or the way in which company value relevant intangibles changed with circumstances, time and learning (Catasus et al 2007, Cuganesan, 2005) created problems of definition, measurement and public reporting for both management and analysts. However, these issues were more difficult for analysts than for company management. Compared to company management they had no control over the use of intangibles. Despite some analysts having good quality of relations with top management they still had much poorer access to this information, and much less direct experience of how intangibles functioned in the company business model to create value. Thus the differences in information sets could be explained by the information asymmetry existing in the market. The access issues and the idiosyncratic nature of intangibles also encouraged analysts to make use of a narrow set of qualitative and subjective information about intangibles in their intuitive judgments. For example, bank analysts paid more attention to top management HC compared with other types of intangibles, not only because it was important for banks, but also because of the lack of accessibility to information about other intangibles (e.g., analyst A5). They focussed on a few (‘just enough’) key interactions between top management qualities and other intangibles in the business model. Analysts sought to compensate for limited access and experience by the use of contacts and meetings with many companies in the same sector and exploiting these via their comparison skills. As a result they were able to analyse relative intangibles strengths such as top management quality in a superior manner to many managers. Changes in relative rankings were likely to be value relevant information.
Poor quality of analyst relations with company top management adversely affected analyst access to company information, and created information problems and increased information differences. Market for information (MFI) contextual factors also influenced the information exchanges and hence analyst and company information differences. These MFI factors occurred in the form of, negative sentiment towards a company by actors in the social network, and as poor analyst reputation for supplying information. Problems with relations and hence information differences could arise if the company has developed new knowledge intensive but opaque intangibles at the heart of their business model. The latter occurred in banks in the past decades (Holland, 2010). However, the rate of change was so rapid and the bank crisis so severe that bank and bank analyst relationships had been weakened in the interview period. This occurred because of the problems both parties faced in understanding bank models before and during the banking crisis. This increased analyst scepticism about company (bank) subjective information and increased their demands for reliable and comparable measures.
Wider MFI contextual factors effected analyst private information research and production, by favouring certain views of company business models, and forms of analysis for companies (as ‘performativity’). These market social factors were fed back into analyst information research and production and altered its content. When there was poor quality knowledge of company business models amongst MFI actors such as company management, analysts, and FMs, then this limited information research, production and exchange by these MFI actors. Economic circumstances also had an influence on analyst and company information differences. The prevailing economic and real market context affected analyst private information production. For example, during the crisis of 2007-09, analysts favoured information on company financial tangibles rather than intangibles.
These were contributory factors to differences between the analyst private information set and the company management information set.
6. Analyst’s reporting and disclosure of‘soft’ information –public and private.
The research questions asked in this section were;
Why is analyst publicly disclosed information different to its private information set?
Why is the analysts privately disclosed information different to its public disclosure?
The sell side analyst knowledge advantage, and private information production and analysis processes provided the basis for their public disclosure and advice roles. A significant part of analyst private information and knowledge was derived from companies and formed the basis for the analyst’s story of the company value creation process and business model. These internal sources and private information production processes provided the basis for analyst public reports. They also provided the basis for more detailed private disclosure to privileged clients.
Public reports by companies, private information from companies on the company business model and strategy, and perceived recent changes in the business model, were important sources (amongst others) for the development of analyst private information. These sources of information, in turn were the basis for analyst public reports including new estimates of financial numbers (earnings forecasts, company cash flows, leverage, cash levels, and estimated value range for company shares), and for public recommendations (to buy, hold, or sell the shares). Private analyst information also provided the means to develop a public narrative based on the analyst’s version of the company value creation story. The public narrative text was designed to provide some insight into the company business model, as well as support the explanations and ‘news’ (if any) around the analyst’s forecast numbers and recommendations.
These numerical and textual report elements to analyst reports were updated on periodic say quarterly basis or the basis of a corporate strategic event. Disclosure content choices about the narrative component in analyst public reports concerned the scale or degree of analyst explanation of the corporate story of value creation and intangibles and the extent to which the text or narrative was tailored to support analyst public forecast of company earnings, company valuation and stock recommendation. Analyst private disclosure to privileged fund manager clients concerned incremental disclosure content over and above public disclosure. It concerned a detailed narrative of how intangibles created value in the company business model. Over time this contributed to a knowledge advantage amongst client fund managers which allowed them to interpret company disclosure and events and create information before others (Holland, 2006).It allowed them to probe analysts in depth in private and increased the quality of private information flows.
These analyst disclosure processes bear some similarities to corporate disclosure processes discussed in Holland (2005). A conventional finance theory explanation of such analyst reporting lie in the concepts of information asymmetry and principal-agency contracting (Healy and Palepu, 2001). Analysts voluntarily disclose information to fund manager principals and others to reduce information asymmetry and to minimise the agency costs subject to (information) proprietary and production costs. This in turn creates trading business for the analyst investment bank (IB) parent (Groysberg et al 2011).
6.1 What the differences were.
The case data revealed differences between analysts public information set (as narrative text) compared to the analysts private information set. This concerned differences such as: • Less analyst public information on intangibles in their public reports both as qualitative discussion (narrative text) and as quantitative indicators • Caution in including company management public measures of intangibles in their public reports due to perceived problems of measurement, comparability, and potential manipulation and bias by management. • But more prepared to include negative news based on intangible measures in their reports. • Higher focus on tangibles measures especially financial measures in analyst public reports • Lower emphasis on explanation of the business model and the role of intangibles in value creation • Little emphasis on the interactions in the business model and how they led to value • Analysts recognised that their private information set based on company information could be manipulated by company management. They made full use of qualitative company information in their private information production but used it with caution in the public domain. • In contrast, the analysts placed more emphasis on using their own qualitative information, text and discussions for public justification of their forecast numbers and recommendations • The analysts also placed more emphasis on using their own qualitative information, text and discussions for impression management
As noted above analyst public disclosures about a company, were based in part, on analyst private information as well as many public sources (including company information). The analyst public information set (as narrative text and indicators) was an adapted and restricted version of its private information set. It focussed on the same broad areas such as the company business model and its value creation effectiveness in the immediate competitive environment and wider economic environment. It included information on how company value creation led to earnings and other accounting and financial numbers. However, the analyst public information had different emphases, focuses, and priorities in these relative to the analyst’s private information set. The analyst’s public information set did not have the same substance or content as its private information set. The public information content on company intangibles was reduced. It was a ‘shadow’ of the company management information set.
6.2 Analysts views on differences in their public and private information sets
Many manager and analyst interviewees expressed concerns regarding the reliability, auditability and comparability of intangible measures that they used. Analysts found that it was difficult for them to get reliable information about intangibles to assist in their bank valuation and to use in their bank reports.
In part, this was because bank top managers were themselves reluctant to report (externally) detailed information about intangibles, and this seemed to further deepen the communication gap between them and analysts. Intangibles were key sources of competitive advantage, and information about them was commercially sensitive for the case institutions. These problems exacerbated intangible measurement problems and reporting for the analysts. Thus many analysts recognized that they had limited access to information about intangibles in the public domain. For example, analyst A5 mentioned that they got very poor information about some intangibles, such as brands or information related to employees.
Similarly, when asked whether or not intangible measures were available in public, analyst A2 remarked,
“[F]or the most part, they [banks] keep all to themselves. I can tell you for sure [that] these things [intangibles] get measured all the time… Banks themselves are very keen to get that information and to see how they are progressing compared with their competitors. That’s true, but they don’t always share us with these.” (Interview A2)
Even when information on bank intangibles was available in public, some analysts tended to doubt the reliability of them due to the problem of information manipulation (A1, A2, A5, A6, and
A10). Warning indicators or some negative intangibles were considered important by analysts. However, banks tended to only report positive information about intangibles.
As analyst A1 pointed out, “companies will never tell you when they are uncomfortable with some things”. Analyst A6 argued that banks had a tendency of being “overlarge with evidence of their brilliance”.
Similarly, analyst A2 criticized,
“[W]e think [that] the bank tends to tell things when there is good news maybe. So they tell us their employee satisfaction rating remains extremely strong, you know, whatever they’ve measured, and they want to tell us good things. That’s the problems we have, you know, because that information is not requested in mandatory account. Therefore it is up to the bank who chooses what they want to tell us.” (Interview A2)
Owing to the manipulation of information, the usefulness of publicly available intangible information was potentially reduced. Analyst A2 noted that although he thought intangibles were important, it was difficult for him to get reliable information that he could use for analysis and for public reports . Additionally, the usefulness of intangible information was also lowered by problems of comparability or consistency of intangible information.
These problems led the analysts to make as much use of this information in their internal information production and analyses, especially when they provided insights in changes in company value creation processes and hence value as expressed in the stock price. However, these problems meant they were very cautious about using this information in their public reports and exchanges of information.
Problems of comparability restricted the usefulness of company intangibles information in their analysis and public reports.
For example, analyst A10 remarked that she was not really interested in some kinds of information about intangibles, such as employee or customer survey results,
“[B]ecause it is very difficult to compare one with another – there isn’t one company doing all the surveys… So you’re not sure if it is level-playing field… they [banks] don’t tend to be honest to you. Their disclosure is not consistent. So they tend to give you once, but they don’t tend to give you again.” (Interview A10)
Analyst A2 argued,
“[I]f you had comparison between the banks in terms of, for example, what customers thought about their brands, from extremely good to no good, then UK banks will, when you do that, tend to be all bunched together. If you have that type of analysis, then it’s very valuable, because that’s what we can use.” (Interview A2)
Despite these problems of information availability, measurement, comparability, manipulation, and bias analysts expressed an increasing need for quantitative information about intangibles and the linkage between them and institution financial performance.
The case analysts discussed how they sought to acquire (and exploit) relevant information about company intangibles from independent sources in order to develop their valuation and reporting capability. Analyst A10 mentioned that most of the intangible information she collected was from public domain sources, such as annual reports and independent reports of brand survey (e.g., Interbrand).
Analyst A9 demonstrated that he tried to collect as much information as possible from public sources.
“When I analyse a bank, I’m looking at everything, really….what I depend on is the banks’ regulatory filings …such as the annual reports etc., but also based on anything I can get my hand on. For example, I mean in the credit crunch, I spent a lot of time reading credit rating agencies’ reports…” (Interview A9)
Some other analysts emphasized that a large part of information about intangibles that they acquired were from private channels (A6, A8, and A12). Analyst A8 pointed out that analysts normally collected information about intangibles that was not presented in the annual report through “a number of different touch points”. He illustrated that one of the ways was to spend time on management in the bank, such as looking at their track record or meeting with them.
Similarly, analyst A12 noted that private meetings with bank managers and managers’ track records helped him to get useful information about intangibles. Analyst A6 noted that investors and analysts liked to meet the CEO or CFO in the bank, and they also tried to have private meetings with other managers.
These varied sources of information on intangibles were valuable for them to explain or predict the value creation process and the crucial factors that create superior financial performance in banks. This information formed the core of their public reports. For example, analyst A 10 said that, “…I am really interested in it [intangible element] if I can see a monetary issue attached with it and a way to prove it. And those are very difficult…You know, my job is to tell you how much a company is worth under certain parameters and certain scenario.”
Similarly, analyst A2 pointed out that,“As for the other [intangible] elements, the problem is although we know they are very important, it is hard to quantify them. So when analysts look at companies, we’d like to do a lot of analyses and that tends to be based on quantitative data and broad hard data. When we talk about intangibles by its nature, it’s soft data. It’s hard to assess the value of it.”
The above statements show that analysts were also concerned about reputation issues for them when disclosing information to the market (Jackson, 2005). They had IC related incentives to bias or adjust their public information outputs based on their interests. Analysts prefer to present themselves publicly as logical, numerate, and ‘scientific’. They prefer to disclose less ‘soft’ information, and less difficult to measure company IC information in their public reports.
Most of the analysts interviewed acknowledged that they did consider intangibles when they assessed a bank. Although such information could not be put in their public reports that were formal explanations of their stock recommendation, analysts thought about intangibles privately when they made recommendations to clients.
As analyst A5 stated,
“I can’t put that [intangibles] into financial numbers. But I can, when I’m thinking about whether I recommend people should buy or sell the shares, I do take into account [intangibles]. I think those are important issues…” (Interview A5)
Similarly, analyst A2 pointed out that information about intangibles that analysts could get was “a little bit unsatisfactory”. As a result,
“[I]t’s not regular and systematic to look at intangibles and track value of intangibles...it’s not reliable to do that. But we will comment on that. We can’t do chart, we can’t do excel or spreadsheet on it. But we can comment [on it], such as Lloyds TSB has one of the best return on equity, one of the reasons for that is its franchise value is very strong, and it tends to get very good customer relationship management, cross-sell other products and so on…So we tend to say, yes, they have done that, [and] that got to be their strength. [It’s] hard to quantify this,… but that’s definitely something [in there].”
Therefore, it is evident that there was a difference between analysts’ public reports and their private thinking. Although they could not make judgements based on some intangibles in their analysts’ reports, they were thinking about those all the time and communicating such information with their clients
The analyst’s private access to company information and their private use made company public reports less useful to them. This is consistent with the findings of Campbell and Slack’s (2008) study, in which they find that narrative reporting of the corporate annual reports that contained information about intangibles tended to be relatively unimportant or unhelpful to bank analysts. In this study, most of the bank analysts recognised the importance of intangibles in banks’ business success. Additionally, the majority of the analysts interviewed had some ideas about the key intangible elements and how they played a role in creating competitive advantage.
Most of the analysts (mixed methods) claimed that they did consider intangibles when they assessed a bank. Although such information could not be put in their public reports on the grounds that their reports had to be based on accurate analysis rather than personal judgements, analysts thought about intangibles privately when they made recommendations to clients.
In summary, because of the problems with intangible disclosure, such as sensitivity, reliability, auditability, and comparability of intangible information, as well as information manipulation, the case banks tended to be unwilling or found it difficult to disclose much information about intangibles. Analysts perceived that some intangible information was useful for them in their private information production but was not reliable for their public reporting
Although many analysts doubted the usefulness of intangible disclosures, they recognized the importance of intangibles and acknowledged that there was a need for standardized, reliable and comparable intangible information, as showed in the above quotation of interview A2.
6.3 Why the differences?
Public reporting by analysts:
These differences arose because analysts altered their private information sources in public reports to match the perceived needs of their fund managers and other external clients operating in financial markets. Analyst private information was also ‘adjusted’ for public disclosure by the analysts by the influence of a combination of (MFI based) social and economic factors, as well as economic circumstances.
Market for information (MFI) contextual factors in the form of a social network made up of multiple relations between analysts, clients and other users, and shared sentiment and perception of analyst reputation and credibility in the MF social networks, also influenced the private disclosure content and behaviour by analysts. These social factors affected the choice of which parts of the analyst private information (as narrative text) should be disclosed in public reports, (and in private discussions with privileged clients). These factors included inter alia; established MFI practices such as standardised analyst reports: social forces or norms in the MFI network (see section 7.1 for details) influencing analyst behaviour and ‘news’ biases: economic incentives and competitive advantage issues: as well as economic circumstances. The idiosyncratic nature of intangibles combined with these MFI factors and economic circumstance in influencing analyst’s public narrative. As a result, the key text (words and sentences in narrative) used in the analyst public reports did not fully reflect private information production and analysis (based on company business models). The analysts public report narrative about intangibles in value creation became a ‘shadow’ of analyst private information and company information.
The market for information social context affected analyst public disclosures (as narrative text) in their research reports, by favouring standardised analyst reporting formats for companies (as ‘performativity’). Analyst structured their report using the ‘standard’ summary and detailed structure. They used standard words and expressions, for ease of comparison. (Breton and Taffler, 2001).
Behavioural factors (Fogarty and Rogers 2005) and market incentives (Healy and Palepu, 2001) were important factors for analysts. Analysts used key text (words and sentences) in their public report narrative to justify recommendations and forecasts. Analysts were careful to use a form of words that did not create ‘hostages to fortune’ in the MFI. There was less chance of saying something that turned out to be very wrong. The analyst hedged their opinion bets and the risks facing their reputation (Jackson, 2005). Analysts needed to protect their reputation in the MFI and to project their use of ‘scientific’ method. This was a form of ‘impression management’ and corresponds to research by Chan et al. (2007), Mehran and Stulz (2007), Abhayawansa and Abeysekera (2009), and Abhayawansa and Guthrie (2012).
This suggests that the content of qualitative (non financial) information and the balance with numeric (financial) information in analyst reports was driven more by impression management than the need to inform. Given that the analyst public narrative was tailored to match their numeric estimates, it was unlikely to have any incremental information content or value relevance for stock prices. This situation also creates incentives for ‘early bird’ or private analyst disclosure of company based qualitative information to privileged FM clients.
Analysts needed to attract attention in the MFI. They needed to get people to read their reports. Thus they had a positive ‘news’ and ‘spin’ bias in their report. Like journalists, they did not reveal the full picture they knew. They normally had ‘positive’ news bias (Fogarty and Rogers, 2005) to keep company management and their own IB parent happy (Groysberg et al 2011). The company would then provide the analyst with preferential access to information and give the analysts IB parent their banking business such as trading shares or financing advice (Das et al 1998).
Competitive advantages in information production and reporting were important. The analysts ‘herded’ around public consensus forecasts and public explanations in the MFI as they had economic incentives not to contradict the general market consensus (Jackson, 2005). This was especially true where they had ‘soft information’ and subjective insights they could not back up with ‘scientific evidence’ or replicable numbers based on measurement of IC intangible value drivers. They also had incentives to tell company value creation stories in positive ways (Campbell & Slack, 2008; Fogarty & Rogers, 2005). Analysts’ interests were in part, aligned with the interests of the companies they were analysing and with improving company information access. They were also aligned with the interests of their information user clients such as large fund managers. The SEC in 2001 issued guidance on how conflicts of interest here could be recognised and avoided.
Analysts operated in their own ‘community of practice’ or social context in the wider MFI. This involved networks of analyst-analyst relations in a professional community of analysts. The quality of inter analyst relations affected their shared states of confidence, trust, reputation concerning each other and their forecasts and recommendations for companies. They also had shared knowledge such in standard investment routines, valuation models, and ideas of market behaviour and pricing. Analysts also shared behaviour when they ‘herded’ around public consensus forecasts and public explanations about companies in the wider MFI.
The intangible interactions in the company business model did not necessarily have a positive impact on value. During the 2007-08 banking crisis, a small numbers of banks had poor top management quality (as in their knowledge of the firm and industry, and ability to execute strategy) and this had a negative impact on other intangibles (such as innovation skills and focus, and risk management skills) in the bank business model leading to failure. This corresponds to Mouritsen’s (2006) view that under dynamic circumstances IC assets can be transformed into IC liabilities. Similar failures arose with bank analysts and other MFI actors such rating agencies and fund managers (Holland, 2010). The lack of general understanding of bank, analyst and rating agency models (amongst others) altered sentiment in the MFI social network and wider society towards these information processes (Turner, 2009). The prevailing economic circumstances and adverse changes in sentiment in MFI social networks after the crisis affected analyst public information production. Analysts favoured information on company financial tangibles rather than intangibles, both in private information production and public reporting. They indicated that these information preferences were likely to change back to a stronger emphasis on intangibles as banks and economies recovered.
Private analysis and private disclosure by analysts:
Analysts also had incentives to protect a perceived knowledge edge they could exploit in private and keep secret. They needed to project an impression of their competitive advantage in information production, without revealing what it was. As a result in the MFI context, they did not reveal all of their qualitative and quantitative information in public. They disclosed a subset of their private information in the public domain, but they concealed much of their own private information on which the judgement was based. They did not wish to reveal their special knowledge advantage (SCA) or lack of it in information production. They did not wish to publicly reveal that had been ‘unscientific’ by using qualitative and subjective information in intuitive judgements and decisions concerning earnings estimates and company stock valuations. The above constituted a prior analyst framing of analyst reputation and credibility changes leading to asymmetric personal financial gains and losses that was similar, in some respects, to Tversky and Kahneman’s (1992) model. Thus there was no contradiction between analyst’s private interest in, and use of, information on company intangibles, and their very limited public disclosure of this information. The differences reflected their ‘social logics’ as well as economic incentives.
This was an ongoing problem given the idiosyncratic nature of intangibles or the way in which company value relevant intangibles changed with circumstances, time and learning. Their interactions, their complementary nature, and (multiple) causality links with each other and with tangibles and subsequent generation of performance and value, all varied over time and circumstances (Catasus et al 2007, Cuganesan, 2005). This encouraged analyst private internal use of qualitative and subjective information in intuitive judgements, as well a more rational analysis and processes.
The idiosyncratic nature of intangibles, changes in social network sentiment, and the potential for loss as well as value gain (financial and credibility) created problems of intangible definition, measurement and public disclosure for both management and analysts. These factors created problems for analysts in their public disclosure in reports. As a result, the analysts public report narrative about intangibles in value creation became a ‘shadow’ of analyst private information and company information.
Why is the analysts privately disclosed information different to its public disclosure?
These same factors also created opportunities in private disclosure to privileged clients. They created opportunities for private story telling about company value creation making use of qualitative and subjective information and intuitive judgements about company intangibles. Thus, in contrast to public reports, the analysts private report narrative about intangibles in value creation was much richer and served many purposes including enhancing analysts credibility
The story or narrative medium was a better match to the private talk or conversation process than a formal report. Getting this right was a key credibility issue for analysts with their clients. In private, analysts had incentives to deviate from the public consensus in their internal information production. They had incentives to reveal some of their private and subjective information about their ‘outlier’ views in their private meetings with privileged clients such as large fund managers. This private domain increased their degrees of freedom in telling and interpreting the company story of value creation and the role of intangibles. It increased their freedom in explaining how they had made the ‘leap of faith’ in translating their knowledge of these matters into numerical estimates and valuations (Holland, 2006). It increased their freedom to talk about sensitive intangible issues (eg managerial ethics or increasing hubris) or about IC matters (eg perceived changes in brand power) that were important but difficult to quantify.
The quality of analyst relations with FM clients affected the credibility of analyst’s private disclosure of company information to their clients. High quality relations encouraged similarities between analyst private information set and private disclosure to clients, and poor quality relations created information differences. The analyst’s private 1:1 meetings with clients, based on trusting and stable relations were important means for exchange of information between both parties. They were means for analysts to respond to client information demands and to problems such as measurement issues. Analyst public reports and analysis, private opinions, public forecasts, and recommendations were discussed with FM clients. Analysts needed to have good reputation, a good track record for analysis and communication for clients to be willing to meet them and to provide share trading business to the analyst broker function. They needed to invest in client relations over time (cf Fogarty & Rogers 2005 and company relations) to ensure that the private exchange of views and information continued and was fruitful.
These were contributory factors to differences between the analyst public information set and the analyst private information set, and between the analyst private and public disclosures.
7. Theoretical interpretation and implications of the paper
In this section, the comprehensive theoretical frame developed in section 2 is used to interpret how ‘soft’ information about companies changed through the analyst intermediation processes (research, analysis, reporting) and through their ‘relationship’ interactions with companies and fund managers in the wider market for information (MFI). It is also used to interpret and respond to the many knowledge and social problems to be found in analysts and the wider MFI. The empirical insights on analysts and theoretical analyses can be used as illustrative e examples for other information market firms (IMFs) such as FMs, auditors, rating agencies, financial media and others.
The empirical results have shown the central role of knowledge and social forces in information market firms such as analysts and in the wider the MFI. Various authors are used as sources to explain the role of knowledge, social and economic forces in the wider MFI, and in the analyst information intermediation process. Major ongoing knowledge and information problems and failures occur in analysts and the wider MFI. In the pre crisis circumstances of 2000-07, various negative knowledge and social factors combined forces (Holland, 2010) and created a negative and destructive spiral leading to failure in connected economic processes such as company (bank) disclosure, in analyst intermediation, and in MFI functions. This suggests the direction for reform and change lies in influencing knowledge, social and economic and factors to create ‘intelligent accountability’ conditions (O’Neill, 2002) for the wider public. The theoretical discussion of analyst problems and related MFI problems also suggests that a more critical, sceptical and reflexive stance, (relative the use and misuse of such knowledge in analysts and the MFI), is required for reform and change.
7.1 The role of market based – knowledge, social context, forces and logics – in analysts and MFI – on analyst intermediation processes and shared use of knowledge in the MFI.
The empirical results have shown the central role of knowledge and social forces and economic incentives in economic processes in information market firms such as analysts and in the wider the MFI. They have revealed the impact of combined knowledge and social factors in the MFI on analysts, on analyst relations with companies and clients, and on subsequent information based economic processes. Differences in company and analysts, knowledge, and social and economic logics (internal and external) played a key role in the differences in their private and public information set. The knowledge factors and social forces influenced economic processes such as analyst’s acquisition of ‘soft’ information from companies, analyst internal processing of this information and analyst disclosure and reporting activities. The joint use of company business models and analyst information intermediation models have illustrated the deep and often hidden knowledge links between company, analysts and fund manager participants in social and economic processes in analysts and the MFI. Analysts are not passive in the face of these influences. They exert counter influence over the external world. Analysts conduct their behaviour and actions as part of ‘impression management’ in their ‘relations’ context, in the wider MFI social network context, and inside their own parent firm. They seek to maintain reputation and credibility in ‘relations’ and wider MFI social context, and in their own firm. Authors such as Johanson (2001), Henningsson (2009), Mackenzie (2006), Meusberger (2009), Knorr Cetina and Bruegger (2002) are used as sources to explain the role of knowledge, social and economic forces in the wider MFI, and in the analyst information intermediation process.
The case data revealed that the analysts were conventional information intermediaries involved in research on the role of intangibles in company business models, adding their own analysis, and providing public advice to the market. The case analysts compensated for some of the problems of using (and making sense of) company (bank) IC information, by exploiting their high quality internal research and analytic capabilities.
The role of knowledge in analysts and the MFI:
The joint use of company business models and analyst information intermediation models are novel examples of the deep and hidden knowledge links between participants in the MFI. In more general terms all major MFI participants had such links. Company top management, investment banks (IBs) and their sell side analysts, core FMs and their buy side analysts, and other market for information participants had linked business models. Knowledge of business models in companies, analysts and other market actors had a strong complementary nature or two-way and multilateral dependency. Companies and analysts, and other information market actors, needed to understand their own and (the broad outlines of) their ‘information counterparty’s’ economic processes. Such knowledge was required so that both parties could manage their own internal economic processes, agree on their common information supply-demand agenda, and hence complete their market based transactions.
Bordieu’s (1977, 1990) ideas of habitus, field or domain, cultural capital and tacit knowledge provide a framework to interpret the empirical insights into the role of knowledge about company business models and analyst information intermediation models in market networks. It provides new ways of thinking about the role of knowledge in social networks in the MFI. Analyst and company top management knowledge was part tacit and part explicit knowledge. In Bourdieu’s (1977) terms the tacit component was a set of practical abilities of the analyst (and their teams) embodied in their skilful behaviour in the domain of information production and exchange (populated by market actors’ such as company managers, other analysts, fund managers and stock markets). Knowledge of company business models was both explicit and tacit. Tacit knowledge was not consciously possessed by analysts or other ‘market for information’ actors (such as company management, or fund managers) or formally articulated by them, but it did nevertheless regulate their activities. The knowledge played a role in producing their actions including information production and disclosure.
Learning and successful provision of information services by analysts and others in this domain were means by which the elite network in the MFI, their hierarchy and shared knowledge were reproduced. Individual analysts in their teams and firms learnt the elite network rules in the MFI by continuous action and interactions in their taken-for granted background to everyday work life.
This theoretical perspective draws attention to knowledge issues in the MFI, and reduces the dominance of information issues. This change in emphasis can raise the understanding of market actors, and for this to stimulate action to reduce the knowledge and information failures in more normal periods and during crises involving the MFI. It also highlights the role of implicit and tacit knowledge and the opportunity to make parts of this more explicit and comprehensible to many analysts and MFI participants.
The MFI social context
The MFI social context refers to various social factors and ‘forces’ operating in a social networks context and their influence on analysts. The social factors and ‘forces’ include norms of behaviour and a culture of secrecy in the MFI. They include understanding, consensus states and confidence states in the MFI. Key MFI based factors include the perceived reputation and credibility of company management and analysts as information sources. Knowledge is a key dimension of the MFI social context. It includes collective stories and shared knowledge both tacit and explicit. It includes collective ‘social blindness’ in the form of conservative and dogmatic views of knowledge and how to use knowledge. Performativity pressures or pressures to only think and operate within ‘established knowledge’ also exist.
Sub sets of the social networks are important. These include analyst relations in networks, with companies, other analysts, other information market firms, and with clients such as FMs. The quality of relation impacts on the quality of information flows in external acquisition from companies, internal analyst processing, and external reporting to clients. High quality information exchanges are expected with high quality relations. The latter would include stable and regular interactions, and high states of confidence, trust, reputation, shared assumptions of behaviour and shared knowledge (eg about IC in company business model) between the parties. The internal social context of the analyst’s parent firm is an important source of social forces for individual analyst. These include the nature of the hierarchy or organisation, organisation process, and firm wide knowledge. It includes external analyst firm factors such as reputation, culture, and power. The analyst own skills, capability, reputation are important contextual factors in the information intermediation process.
Analysts’ social relations in a MFI network context:
Analyst operated in knowledge intensive social networks and relationships both on the supply and demand sides of the market for information. On the supply side this involved relations (in networks) with many companies in a sector or a small group of sectors, as well as relations with information specialist such as Bloombergs. States of confidence, trust, reputation, and shared knowledge in these relations and networks were critical to the flow of information and exchange of knowledge between companies and analysts. On the demand side this involved external relations (in networks) with many client FMs and others. States of confidence, trust, reputation, and shared knowledge in these relations and networks were also critical to the flow of information and exchange of knowledge between analysts and their clients. Another part of this social context was the wider professional network context of many analysts and their shared characteristics. Properties of the social context included their shared assumptions and knowledge, their consensus analysis/forecast for companies (banks), and their incentives for disclosure and analyst rankings. The wider information network also consisted of many analyst relations with other information-production professionals such as company rating agencies and auditors, and many information users such the financial media and regulators. An important social context also included internal relations with other information users in the analyst’s parent firm, as well as shared culture, knowledge and aims within the firm.
Analyst activity in the social network context:
Analysts were active participants in the social networks in the MFI, and played an active role in the social construction of knowledge about the company business model and analyst models, and in using this knowledge in information production. They played an active role in constructing states of confidence for information concerning a company. Analysts also played an active role in the social construction of the consensus company value creation story (or myths) about the role of intangibles in the business model and how this led to value and valuation (Holland, 2005). The consensus, in turn had an impact on analyst public and private disclosure of company IC information.
The dynamic character of the social dimensions of the information market network was also demonstrated by everyday interactions between analysts, companies (banks), FMs and others. Differences in information needs of MFI actors, changes in the economic and business environment, stimulated reflection, changes in consensus views and encouraged learning. Learning and change in the companies (banks), drove learning on the analysts (and by implication in others in the network) about company (bank) IC and its changing role in company (bank) value creation and value. These empirical observation reflect the ideas of ‘community of practice’ (Lave and Wenger, 1991) and the broader theoretical view suggested by Bordieu (1990).
Interpretation of - Analyst activity in the social network context:
The case analysts used these network based relationships in the MFI to secure or disclose ‘soft’ information so as to compensate for some of the (measurement and definition) problems of making sense of, using and reporting on bank IC information (Holland et al 2012). Sections 4 to 6, illustrated how analysts were influenced by social forces in the MFI network when they observed, researched, processed and narrated company IC information. Social logics about their own specific tasks, their host firm, the market price, and the social agenda around certain banks, analysts, and FMs played a role in the subjective and social construction of ideas and information about bank IC and value creation, and in reporting such information.
The case analysts operated in an external world where they had to demonstrate analytic and numeric skills. They did not reveal the subjective, intuitive and emotional dimensions to their decisions (Holland et al 2012) especially concerning the use of subjective information about company intangibles. They could not risk their perceived reputation for ‘rigorous and scientific’ analysis in the MFI. They had wealth and information access incentives to bias their own IC and numerical disclosure outputs to match (fund manager) shareholder client needs and relationship company needs and to maintain their reputation in the MFI. This bias and impression management behaviour corresponds to research by Chan et al. (2007), Mehran and Stulz (2007), Abhayawansa and Abeysekera (2009), and Abhayawansa and Guthrie (2012).
The idiosyncratic nature of intangibles, the possibility of sudden changes in social network sentiment, and the potential for loss as well as value gain created problems of public disclosure (about company intangibles) for analysts and limited their public narrative. They also created opportunities for private story telling by analysts about company value creation and intangibles. Analysts had incentives to reveal some of their private and subjective information about their ‘outlier’ views in private meetings with large fund managers. Thus the analysts could ‘perform’ one idea of company intangibles and value in public and another in private (Mouritsen, 2006). ‘Impression management’ was important in public and ‘client relationship management’ was important in private. The performance and mobilisation of company IC based intangibles by analysts and hence its meaning to MFI actors varied according to domain. It was intended to have different effects in each domain. It was intended to have different but complementary effects on the construction of facts or shared meanings about company value creation and value in the MFI social and economic networks (Latour, 1993) made up of company management, fund managers, other analysts and others. In this way the corporate narrative about the role of intangibles in the business model was incorporated within the analyst analysis and reporting processes and was reflected in the ‘mirror of the market’ (Roberts et al, 2006).
Knowledge issues and social context thus mattered in the analyst research, production, use of information and reporting in this market. Analyst’s private production of information via interactions with companies, and their decisions to publicly or privately disclose information about companies were driven by shared knowledge, by acceptable forms of social behaviour in markets as well as by rational economic analysis and calculation. These analyst information processes and behaviour correspond to Henningsson’s (2009) view that external observers such as analysts and fund managers (shareholders) were ‘cultured observers’ of companies and their IC information.
Differences between analysts and company (bank) management:
The empirical findings reveal that differences were found between analysts and company (bank) management on such issues such as their understanding and definition of intangibles, measurement of intangibles, perceived absolute and relative importance of intangibles, and the role of combinations of intangibles. Differences in social logics (for company managers, for sell side analysts and for fund managers) and in their economic logics (or in the nature of their aims, specialist tasks and decision processes) played a role in the differing viewpoints about company (bank) business models, measurement of intangibles, and links to company performance outcomes. Social forces and the other factors also played a role in their differing views on the problems of quantitative measurement of IC based intangibles in company value creation and preferences for qualitative measures. As a result, these social logics played an important role in creating differences between company and analyst information production and sets, both private and public, and in influencing their disclosure behaviour. These led to communication gaps between companies and analysts.
7.2 Problems of knowledge and information production in the MFI
Major knowledge and information problems arise in the market for information (MFI).
Major ongoing knowledge and information problems and failures occur in analysts and the wider MFI and undermine their economic processes and functions. A key problem concerned the idiosyncratic nature of corporate intellectual capital (IC) or the way it changed with circumstances, time and learning (Catasus et al 2007, Cuganesan, 2005) creating problems of definition, measurement and public reporting for both management and analysts. The increasing intangibles component to company value creation caused deterioration of the quality of corporate private disclosures to analysts (Holland, 2005) and in analysts reporting in the public domain. This can cause poor understanding of (the role of knowledge in) company business models and analyst intermediation models by actors in the MFI. The problems also included privileged access and exchange of information which were counter to the interests of the wider investing public. Conflicts of interest (COI) arose in social networks of relations in the MFI, such as between analysts and companies, and analysts and clients (SEC, 2001). Henningsson (2009) argued these knowledge problems can combine with (conservative and unchallenged) social factors (and with the COI) and create ‘social blindness’ (Henningsson, 2009) amongst market actors. This in turn can distort analyst and market functions and processes for information production and exchange. As a result they do not understand (or do not wish to understand) new phenomena such as the role of IC in companies and their value creation. They have poor understanding of (the role of knowledge in) company business models and analyst intermediation models, and this can impact on their specialist information roles and the wider MFI functions.
Various social factors can combine forces and intensify such ‘knowledge exposure’ problems in the MFI and create a negative and destructive spiral in market economic processes. They can distort the shared exchange and use of available knowledge and information between transmitters and receivers and contribute to underperformance and failure of the MFI. Meusburger (2009) has noted that limited skills, experiences and cognitive processes of the transmitters and potential receivers of knowledge and information were important factors in knowledge exchange failure. Events in financial markets during the crisis of 2007-09 have shown how misbehaviour by key economic actors in the MFI social context played a central role in distorting the exchange and use of knowledge and information in the MFI (Holland, 2010) leading to failure in company (bank) disclosure, in analysts and in the MFI. Negative knowledge and social factors intensified ‘knowledge exposure’ problems in the MFI (Holland, 2010) and destabilised economic processes in the MFI. These problems included: Top management characteristics (hubris, poor knowledge of business model); inappropriate financial incentives and the overwhelming dominance of wealth aims with these incentives and aims poorly connected to risks; poor knowledge of risks and their management; highly risky strategies and actions by companies; by analysts and investment banks; high conflicts of interests and abuse of power; shared cultures of secrecy; the high rate of change relative to learning capability; disincentives to learn; as well as ‘hot’ high value transactions and ‘bubble’ market circumstances; and emerging corporate performance problems. These all combined and interfered with specialist intermediary functions in analysts, fund managers, auditors, rating agencies and others leading to MFI failure and wider financial system failure.
These examples demonstrate how knowledge, social, and economic factors can combine in the interest of elite participants in the MFI and create negative outcomes for the many. The factors can interact under specific conditions and be part of a spiral of negative interactions in the MFI and play a role in distorting business models and shared knowledge of them. This can create a ‘daisy chain’ of linked ‘ignorance’ conditions and ‘knowledge exposure’ across the MFI for analysts, auditors, credit rating agencies, FMs and others. This can be interpreted as a negative version of Merton’s (1995) ‘financial innovation spiral’ in the MFI. These conditions can distort the information production, exchange and use of IMFs ‘information’ outputs with each other. For example, this can create analyst report biases and other IMF information output problems concerning corporate performance and risk. These problems can interfere with MFI processes and functions and with knowledge and information use in companies and markets. This paper argues that shared and explicit public knowledge of company business models, of analyst business models, and of other information market firms business models, is part of the solution to these problems.
7.3 Policy changes - Improving network actor understanding of company business models and of analyst models in the market for information
The paper reveals how the MFI social context and social forces and associated knowledge, the related relations factors, the internal social context of analysts parent firm, and individual analyst characteristics all influence information flows in the analyst intermediation and the observed changes in ’soft’ information. Analysts are not passive in the face of these influences. They exert counter influence over the external world. Analysts conduct their behaviour and actions as part of ‘impression management’ in their ‘relations’ context, in the wider MFI social network context, and inside their own parent firm. They seek to maintain reputation and credibility in ‘relations’ and wider MFI social context, and in their own firm.
Knowledge, social and economic factors can combine in the interests of elite participants in the MFI and financial markets and create negative outcomes for the many. Problems and misbehaviour in the knowledge and social contexts can distort economic processes in analysts, the MFI and financial markets.
The paper argues that reform requires active mobilisation of both knowledge and social forces to improve economic processes in analysts and the MFI to provide benefits to the wider public rather than a privileged few. Improved knowledge of business models of companies, analyst and other MFI actors can also reduce problems in the social context. The development of critical and reflexive performativity can mobilise knowledge and social forces in the interests of the wider public.
The problems identified in the previous section suggests the direction for reform and change lies in influencing knowledge, social and economic and factors to improve economic processes in analysts and the MFIs and to create ‘intelligent accountability’ conditions (O’Neill, 2002) for the wider public. The problems illustrate the need to improve understanding about the role of knowledge (empirical and theoretical about companies, analysts and others) in the market for information. More specifically they illustrate the need to improve understanding of company business models and of analyst models by a wide range of participants in the market for information. They indicate the need to develop knowledge of how company and analyst economic processes (and their models) are connected and used to exchange information. They highlight the need to understand such connections across all actors in the MFI. The paper also argues for a more explicit sharing and transparency of this knowledge, and for an extended theoretical narrative concerning the role of knowledge and social forces. Improved knowledge of business models of companies, analyst and other MFI actors can reduce problems in the social context. However, more active mobilisation of social forces is also required. The theoretical discussion of analyst problems and related MFI problems also suggests that a more critical, sceptical and reflexive stance, (amongst MFI actors concerning the use and misuse of such knowledge in analysts and the MFI), is required for reform and change. A linked research and regulatory agenda should seek to improve the public debate about company and analyst models by market participants to reduce the benefits for knowledge insiders and to reduce systemic risks.
The analysis reveals how explicit business models and an expanded theoretical frame can be of value in understanding and changing finance phenomena.This paper argues that improvements in understanding and transparency; about company business models and about analyst information intermediation models (when using and reporting on company models); are a part of the solution to knowledge problems and their negative impact on markets (functions, processes and states).
In the first case, the empirical results suggest that the creation of common and public knowledge about company business models is required. This concerns the role of IC in company value creation, how companies change over time, how their models are empirically tested, and the creation of new theory (of company value creation) closely matched to this phenomenon. This may be one of the means to bring together these different social systems and their shared and differing perceptions, social logics and understandings of the core functions and roles of company value creation and market use of information.
The specific case of banks, bank analysts and bank investors (FMs) provides a useful example of how the larger ‘market for information’ can be reformed in the wider public interest. The grounded theory of banking developed by Chen et al (2014) has implications for improving bank business models and bank theoretical models. A new bank theoretical narrative (Locke, 2001) corresponding to the empirical findings has been summarised in Chen et al 2014. The resource based view of the firm (Barney, 1991) is a key theoretical component of this narrative. New bank models (empirical and theoretical) are one basis for improving the public and private interpretation and discussion of bank risks and performance.
There is also a need for companies such as banks to disclose more information about intangibles in a structured way. For example, Beattie and Thomson (2010) have argued that there is an opportunity to “investigate whether a set of industry-specific standardised metrics can be developed and their disclosure regulated” (Beattie and Thomson, 2010: 140). This paper shows that there appears to be a need for industry-specific reporting standards or guidelines from both internal managers’ and external analysts’ perspectives.
In the second case, the creation of common and public knowledge about analyst’s information intermediation role can further support the aims of the paper. Investigating how the same type of information changes from analyst research, analysis, and reporting has provided a novel insight into the analyst information intermediation model. The research reflects Lo’s (2012) view that a significant problem in the analyst literature is a lack of knowledge about what analysts do. This creates new opportunities for wider shared understanding about the analysts own value creation or business models (Holland et al 2012), the role of analyst IC in analyst value creation, how analysts change over time, and how their valuation models are empirically tested. This research clarifies how analysts researched companies and exploited ‘soft’ company information, how they produced private information and how they reported information in the public domain.
The empirical results also suggest there is a need for analysts to disclose more information about their intangibles. This has to be structured on a fuller understanding of the role of own intangibles in analyst value creation. This may be the most appropriate way to control analyst behaviour such as over optimism and other biases. Improving the analyst’s interpretive model and clarifying its information requirements is necessary for analysts, company management, fund managers and other actors (e.g. Credit rating agencies), and for wider processes in the market for information. Thus there is a similar need for analyst specific reporting standards or guidelines from external shareholder perspectives and from wider information market perspectives.
Analyst private story telling about company value creation and intangibles to major clients such as large fund managers can also be enhanced. Holland (2009) using literature on storytelling argues for a more structured approach. Analyst’s structure of IC based company value creation stories can be based on three connected value creation subplots for top management value creation and for operational and network value creation (p157). They could also include structured story plots with beginnings, protagonists, and culminating events (P174). Reporting these structured narrative disclosures after private meetings can also enhance transparency and wider understanding.
The creation of new analyst (information intermediation) theory closely matched to this phenomenon may be one of the means to bring together these different social systems and their shared and differing perceptions, social logics and understandings of the core functions and roles of analysts, companies, FMs and markets. For example, a new theoretical narrative (Locke, 2001) for analysts (Lo, 2012) corresponding to the empirical findings in this paper can be constructed based on a combination of new literature and the conventional finance theory narrative. This can be briefly summarised as follows.
Analyst have knowledge intensive intangibles (or Intellectual capital as HC, SC and RC in Meritum, 2002) that are rare, inimitable, difficult to copy sources of value (Barney, 1991). They also rely on core tangibles (e.g. technology, offices) and tangible processes (e.g., management, intermediation, technological). The knowledge intensive intangibles are at the core of sustainable competitive advantage in individual analysts, teams and their parent firms, as noted in the resource based view of the firm (Barney, 1991). These integrated and combined intangibles and tangibles form analyst value creation chains (Porter, 1985), which are the basis for analyst to conduct information intermediation (concerning information about company intangibles and business models) in a more effective way than competitors. This is expected to result in higher performance in forecasting, valuation and advice. Such knowledge intensive analysts, teams and their parent firms provide the means to reduce agency costs and associated problems of information asymmetry, adverse selection and moral hazard between companies and market actors such as FMs, small investors and others. Analyst intangibles provide the means to overcome imperfections by contributing to economies of information specialization, scale economies in information acquisition, and reduction in information search costs.
In the third case, the empirical finding indicate there is the need to develop knowledge of how company and analysts economic processes (and their models) are connected and used to create and exchange information. This highlights the need to understand such connections across all actors in the MFI and hence how the overall market functions.
For example, the paper argues that for existing analyst ‘analytical tools’ (strategic and competitive analysis, and financial valuation models) to work more effectively, requires more explicit connection to be made between company business models and analyst intermediation models. It requires more analyst education and knowledge in the above areas. Analysts require explicit company business models and intermediation models and clear links between them This would be a means for analysts to begin to connect economic variables (and changes in IC) in company business models to financial variables (and to changes in) in existing valuation models in less subjective and more systematic way.
For example (changes in) key intangibles in the company business model (say perceived management skills or hubris, or brand strength) could be connected to (changes in) core competitive advantages (say market leader). These in turn could be connected to (changes in) expected levels of earnings/cash flows, their risks (systematic, unsystematic), and ultimately to value (changes). The search for new IC type information connections to parameters in existing valuation models requires major improvements in public and professional understanding and debate about company business models and analyst intermediation processes. One answer here is for analysts’ professional bodies to encourage the generation or publication of ‘templates’ for ‘company models and intangibles’ that reflect the broad understanding of the analyst professional community in this area. They could provide case examples of how the models were fleshed out in specific companies and key sectors. They could provide examples of how IC factors were connected to financial factors in valuation models. They could provide examples of success and failure here. This could be the analyst community’s contribution to improvements in public debate. This could enhance professional education, understanding and debate about these matters.
7.4 Embryonic theoretical narratives and developing a critical and sceptical stance to narrative.
The paper argues for improved knowledge of empirical models, and an extended theoretical narrative concerning many MFI participants. In particular, the paper argues for improved knowledge of company business models and of information intermediaries such as analysts. Improved understanding and exchange of knowledge (of company business models, and of analyst intermediation models), by actors in the ‘market for information’ (including company management, analysts, FMs and others) can reduce the information differences and barriers thus enriching the information set for capital markets. This shows the central role of knowledge and the need for academics, policy makers and regulators to create an agenda which focuses on knowledge as well as information. This agenda should seek to improve the shared understanding of company models, of analyst models, and connections, by academics, regulators and all major market participants (Lo, 2102, Beattie and Smith, 2013) and to reduce the privileged benefits acquired by knowledge insiders. The idea is to reduce the concentration of knowledge and information amongst the few and spread it out to a wider more transparent and critical public domain. The latter are the source of much of the financial capital employed in the financial system and post crisis require higher level ‘intelligent accountability’ mechanisms (O’Neill, 2002).
New knowledge as empirical models and new theoretical narratives – as a basis for ‘Reflexive performativity’:
The problems and misbehaviour in the social context of the financial system and their role in distorting the exchange and use of knowledge and information in analysts and the MFI, and in creating major problems in knowledge and information areas, suggest that a more critical and sceptical stance is required for reform and change.
The creation of common and public knowledge about company business models and about the analyst information intermediation role, are partial means to reduce the social blindness (Henningsson, 2009), and untested narratives concerning new company IC and business models shared by company management, analysts and shareholders. They are also partial means to ensure that collective stories told in the social context are more grounded than those used in the recent past and more open to collective and explicit criticism and debate.
This is one basis for a more ‘reflexive performativity’ based on empirically tested company business models (and perhaps extended theoretical models) that more fully reflect economic phenomena rather than creating them. Similar comments can be made about improved models of analyst information intermediation and the chain of information research, production, and reporting set in MFI context. Empirically tested models of this information intermediation process in its market context (and theoretical models) are required to bring the hidden economic phenomena into the light of public scrutiny.
‘Reflexive performativity’ is interpreted as including situations where new and empirically tested theoretical models and literature (of, for example, intellectual capital and company value creation, and analyst value creation) become tools used by many market actors (e.g., analysts in their reports, and fund managers in their investment decisions) and where this can be used to modify (information market and stock) market processes in a more open, and public manner.
The above proposal reflects Meusburger’s (2009) argument that care should be taken when assuming how knowledge is created, transferred and used in social and economic systems. This paper has argued that attention should be paid to improving the empirical and theoretical models for company value creation and for analyst information intermediation. This is one means to improve the limited skills, experiences and cognitive processes of the transmitters and potential receivers of knowledge and information.
Understanding and using social system theory – as a basis for ‘Critical performativity’:
Improving knowledge alone is not enough to deal with problems. Combinations of social and economic factors such as incentives, conflicts of interests, power, secrecy, and change are still important factors in financial systems and in the privileged use of knowledge. The previous section has also discussed how various factors can intensify problems in the MFI through the emergence of a negative and destructive spiral. They can distort the shared exchange and use of available knowledge and information between transmitters and receivers and contribute to underperformance and failure of the MFI. Meusburger (2009) has noted that limited skills, experiences and cognitive processes of the transmitters and potential receivers of knowledge and information were important factors in knowledge exchange failure. Additional factors exacerbating these problems include: performativity factors; top management characteristics; financial incentives and the overwhelming dominance of wealth aims; various strategies and actions by companies; by analysts and investment banks; their conflicts of interests and exercise of power; their shared cultures of secrecy; the rate of change; as well as ‘hot’ transactions and ‘bubble’ market circumstances; and emerging corporate performance problems; can all interfere with market functions
The danger here is that the new empirical and theoretical narrative could combine with similar events and factors and create new conditions of unthinking or convenient ‘performativity’ at some point in the future. Hence, a more critical and sceptical stance is required to the narrative. This may best be secured by a wider understanding of the social systems theory and ideas of ‘performativity’ and their application to the empirical phenomena discussed here. This requires a further extension to the theoretical narrative to include these ideas to create a more critical and reflexive ‘performativity’. Thus, the development of empirically tested company business models, of analyst information intermediation models and reporting, and of their theoretical equivalents, within an awareness of social forces and logics is required. This is required of business models and theoretical models and company and analyst reporting formats derived from these models. This contrasts with the case of historic theoretical models (of banks, of efficient markets, of information intermediation) derived from academic generated theory and literature. These, when used in a world of conservative and unchallenged social forces, have proved to be the source of dogmatism. They contributed to systemic risk in the banking crisis of 2008 (Turner, 2009).
The approach developed in this paper is one possible way to ensure that the social forces, noted by Henningsson (2009) can be mobilized to affect the behavior and actions of finance network actors (especially academics and practitioners) in more informed, critical and publicly open manner. Cultural barriers to communication between company managers, analyst and fund managers could be reduced by such wider shared understandings. This provides an opportunity to improve awareness of social systems and their implications for finance both amongst academics and practitioners.
8. Summary and conclusions
The paper has explored how the same type of information changes from analyst research, analysis, and reporting stages and thus provides a novel insight into the analyst information intermediation model. Knowledge and information in companies, analysts and other market actors had a strong complementary nature or two-way and multilateral dependency. The analyst private information set was, in part, a ‘mirror image’ of the company private information set. Analyst public information also partially reflected or ‘shadowed’ analyst private information and company information.
The changing information content was mediated by knowledge, social and economic factors. Issues of intangibles measurement, analyst task, and market factors all played a role. Analyst public and private disclosure was influenced by these factors and by perceived analyst competitive advantage and reputation issues. The analysis in this conceptual frame demonstrated that there was no contradiction between analyst’s private interest in, and private use of, information on company intangibles, and their very limited public disclosure of this information. The differences reflected their ‘social logics’ as well as economic incentives.
The US ‘Financial Crisis Inquiry Commission’ ( Pxvii,Jan, 2011) noted how negative knowledge and social factors can a central play in undermining economic processes in the financial system;
‘We conclude this financial crisis was avoidable. The crisis was the result of human action and inaction, not of Mother Nature or computer models gone haywire. The captains of finance and the public stewards of our financial system ignored warnings and failed to question, understand, and manage evolving risks within a system essential to the well-being of the American public. Theirs was a big miss, not a stumble. While the business cycle cannot be repealed, a crisis of this magnitude need not have occurred. To paraphrase Shakespeare, the fault lies not in the stars, but in us.’
In the recent past, adverse knowledge and social conditions have combined and created major problems in economic processes in analysts and in the wider MFI. This has created information barriers between; analysts and company management: and between analysts and investors: and has led to further problems in the market for information, in stock market valuation of companies, and in the real economy.
The paper argues that reform requires active mobilisation of both knowledge and social forces to improve economic processes in analysts and the MFI to provide benefits to the wider public rather than a privileged few. Improved knowledge of business models of companies, analyst and other MFI actors can reduce problems in the social context. The development of critical and reflexive performativity can mobilise knowledge and social forces in the interests of the wider public.
This paper has argued that three simultaneous solutions are required to respond to such problems arising in the world of finance. They involve improved understanding of company business models and of analyst intermediation models. They include improvements in the theoretical narrative about these models and roles in the market for information. The paper also argues that a more critical and sceptical stance is required relative to the empirical and theoretical narrative. These three proposals provide a new change agenda for researchers, policy makers and regulators. These could create improved social and economic conditions for ‘intelligent accountability’ for the benefits of the wider public (O’Neill, 2002).
The paper explored how improved understanding of company business models and of the analyst intermediation process by all parties on the information network can reduce these information differences and barriers thus enriching the information set available to capital markets. This requires much empirical research into company business models, and into improving analyst understanding and reporting of these models. Similar comments can be made about improving models of analysts’ intermediation processes and the way in which they research, process and change such company information sources. They are both part of the solution to knowledge problems and their negative impact on markets (processes and states) and their economic and social functions
These proposed changes are to some extent a ‘hygiene’ (or necessary but not sufficient) factor. This paper has also argued for improvements in the theoretical narrative about company business models and about roles of analysts and other actors in the market for information. This requires coherent and integrated use of ideas from a range of disciplines including conventional finance theory, ideas of knowledge in economic activity, and ideas from sociology of finance.
Finally the paper also argues that a more critical and sceptical stance is required to the empirical and theoretical narrative. This may best be secured by a wider understanding of the social systems theory and ideas of ‘performativity’ discussed here. This requires a further extension to the theoretical narrative to include these ideas to create a more critical and reflexive ‘performativity’.
This research provides new ways of understanding structures and processes in financial markets. It can provide new means to support research using the conventional finance theory paradigm. It provides a new way of understanding how information is produced, transmitted, changed and used and ‘reflected’ in stock prices (Fama (1970) and stock market efficiency). In ‘behavioural finance’ (Schiller, 2000) it provides a new way of understanding how behaviour is conducted, acted on, biased and potentially aggregated into stock prices and how possibly how behaviour generates the longer empirical regularities to be found in prices (momentum, over reaction etc).
The empirical analysis in the paper concerning analyst information (private and public) and the company business models has been discussed in a novel theoretical literature. This provides the means to think beyond conventional finance theory and ‘behavioural finance’ and the Fama – Schiller schism about the functioning of financial markets (Nobel prize-winners, October 2013) It does this by using network concepts concerning the ‘market for information’, intellectual capital, organisational and social systems theory, and ‘performativity’.
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