Fifteen years ago, “issuer-paid” investment-research boutiques were virtually non-existent. Now there are over a dozen in the U.S. and four (that I could count) in Canada. Their specialty is producing research on small-cap companies. Increasingly, they are emerging as another source of ideas for small-cap investors.
The boutiques publish 15- to 45-page reports, updates and bulletins — just like investment dealers do for larger companies. Investment dealers finance their research from fees collected by their underwriting and trading departments; issuer-paid boutiques finance the cost by charging fees from the companies covered, a method long used by bond-rating agencies.
Research from dealers and boutiques comes with the potential for conflicts of interests. Thanks to growing awareness and regulatory requirements, both providers alert their customers to the possibility of conflicts by disclosing fees and pecuniary interests in their research reports.
But is issuer-based research worth reading? A recent academic study, Can companies buy credible analyst research? concluded their reports had “information content” judging from the above-market gains in stock prices over the two days following publication. If the reports were generally regarded as pure puffery, then one would not expect many investors to respond to their recommendations.
The paper raises an important caveat: the distinction between “high-credibility firms” and “low-credibility firms.” The author defines a firm as being highly credible if it does not engage in investment banking, public relations, investor relations, or trade the stock of covered companies. Market reaction to the high-credibility firms’ reports was much better than to the reports from the low-credibility firms, he said.
One Canadian boutique rated “highly credible” by the paper was Vancouver-based Fundamental Research Corp. When CEO Brian Tang was asked what he thought of the study, he said:
“I’m glad the study differentiates between … “high-credibility firms” and “low-credibility firms”. This is important because there are a few firms out there that say they are engaged in this type of research but also engage in PR/IR, accept stock etc. I think it is important for the investing public and issuers to know that these types of firms do not generate the same type of response as firms with stricter internal controls.”