Client Service, Compensation, and the Sell-Side Analyst Objective Function: An Empirical Analysis of Relational Incentives in the Investment-Research Industry

This paper investigates how sell-side analysts build and sustain their client networks; the economic gains to successfully managing this challenge; and the metrics through which these incentives are delivered. In a typical semiannual period, the average analyst supplies around 80 research notes and three reports; spends around one week brokering meetings between client investors and corporate managers; and holds approximately 750 private phone calls and 45 oneon-one meetings with client investors. Changes in these client-service actions explain approximately fifty percent of the intertemporal variation in broker votes, a mechanism used to measure the value that client investors ascribe to maintaining continued analyst relations, with the strongest sensitivity observed for widely disseminated, thematic, research reports known as whitepapers. Analysts’ client-service actions, however, explain relatively little intertemporal variation in commissions and broker share of trade execution in their covered stocks. Analysts who strengthen their client networks reap significant rewards and, consistent with the informativeness principle, we find these incentives to be delivered primarily through broker votes, not trades executed in analysts’ covered stocks. Our findings contribute to understanding of the job and objective functions of sell-side analysts and structure of relational incentives in the investment-research industry.