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Securities Analysts As Frame-Makers**

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Securities Analysts As Frame-Makers** SECURITIES ANALYSTS AS FRAME-MAKERS** Daniel Beunza Universitat Pompeu Fabra, Barcelona (Spain) [email protected] and Raghu Garud Stern School of Business, New York University [email protected] April 18th, 2005 ** We thank Adam Brandemburger, Michel Callon, Emilio Castilla, Fabrizio Ferraro, Mauro Guillen, Witold Henisz, Robin Hogarth, Donald Mackenzie, Fabian Muniesa, Sarah Kaplan, Peter Karnoe, Javier Lezaún, Yuval Millo, Kamal Munir, Mary O’Sullivan, Naomi Rothman, Graham Sewell, David Stark, Mark Zbaracki and other participants at the 2003 EGOS “Markets-in-the-making” colloquium, 2003 Barcelona Gestió seminar, 2004 Performativity Workshop in Paris and EOI Seminar at Wharton for their inputs on earlier drafts of this paper. SECURITIES ANALYSTS AS FRAME-MAKERS Abstract Whether as brokers, critics or analysts, market intermediaries have received considerable recent attention in economic sociology. As Wall Street specialists on valuation, securities analysts are a particularly important class of intermediary, but their function is still poorly understood: while the academic literature provides a highly critical account of them, analysts have survived and expanded as a profession for almost a century. In this paper we offer a possible explanation for this puzzle with a novel theoretical perspective. We undertake a grounded theory, qualitative content analysis of the reports on Amazon.com written by Henry Blodget and rival securities analysts during 1998-2000. We find that analysts’ reports are structured by internally consistent cognitive networks of associations between categorizations, key metrics and analogies. We refer to these as calculative frames, and propose view analysts as frame makers, that is, specialized intermediaries that help investors attach numerical measures of financial value to stocks under uncertainty, by producing calculative frames. These frames mediate the relationship between information and valuation, providing the material basis for calculation and rational decision-making, but also leading to imitation and continued framing controversies. 2 SECURITIES ANALYSTS AS FRAME-MAKERS Whether as brokers, critics or analysts, market intermediaries have recently received increasing attention in economic sociology. Intermediaries such as brokers were central to the rise of modern economic sociology and the notion of embeddedness (Granovetter 1974, 1985; Burt 1992). More recently, however, intermediaries have gained prominence for the opposite reason: as Granovetter and others turned their attention from embedded to the impersonal transactions typically found in modern mass markets, attention has shifted to the ways in which market intermediaries can facilitate disembedded transactions (Callon 1998; Stark 2000; MacKenzie and Millo 2003; Granovetter 2004). Accordingly, a rich literature on critics (reviewers of art, restaurants or films) has persuasively argued that intermediaries can replace the uncertainty-reducing role played by network ties (Hirsh 1972, 1975; Podolny 1992, 1993; Rao 1998; Zuckerman 1999, 2004). Intermediaries are also at the core of a related move: as economic sociologists come to see markets, rather than hierarchies, as the main locus of resource allocation in contemporary financial capitalism (Flisgstein 2001; Dobbin 2004), intermediaries in the capital markets such as traders, specialists or investment bankers have gained corresponding sociological notoriety (Baker 1984, Eccles and Crane 1988, Davis 1991, Abolafia 1996). Thus, in short, intermediaries are at the core of the current expansion of economic sociology, from embedded to anonymous mass markets and from bureaucratic to financial capitalism. As Wall Street specialists in valuation, securities analysts are a particularly important class of market intermediary. The reports, recommendations and price targets of sell-side analysts are the raw material that large investors use to make their investment decisions. Indeed, analysts have repeatedly been singled out as the main culprit for the overvaluation of technology stocks during the period 1998 to 2000. 3 Our understanding of securities analysts, however, is challenged by a puzzling discrepancy between existing theory and practice. Whereas the academic literature presents a consistently negative portrait of these intermediaries, the profession has survived and expanded for almost a century. Thus, for instance, the orthodox finance literature presents analysts as forecasters and investment advisors but provides mounting evidence that they lack forecasting ability or skill in giving lucrative advice (Cowles, 1933; Lin and McNichols, 1998; Lim 2001). Similarly, the literatures in neoinstitutional sociology and behavioral finance document the tendency of analysts to blindly imitate each other, rather than process the economic information they possess (see respectively Philips and Zuckerman 2001; Zuckerman 1999, 2004; Rao, Greve and Davis 2001; and Scharfstein and Stein 1990, Hong, Kubik and Solomon 2000). Recent sociological work on analysts emphasizes their tendency to punish companies that innovative (Zuckerman 1999). In the light of these findings, the secular growth of the analyst profession cannot be easily understood: if their performance is so disappointing, why do they still exist? In this paper we address this puzzle with a reexamination of the intermediary role performed by security analysts. Following the current sociological emphasis on the uncertainty- reducing function performed by mass market intermediaries, we are particularly interested in the activities of analysts when the value of the companies they cover is unclear, subject to unforeseeable contingencies or under dispute (March, 1987, Knight, 1921). We ask, what is the meaning of security analysis in contexts of ambiguity and Knightian uncertainty? We address this question with a grounded-theory, qualitative content analysis of selected research reports. Analyzing the full text of analysts’ reports provides two unique advantages: it offers an open window on the cognitive processes followed by analysts as it unfolded, and it constitutes an original data source in the study of analysts so far. To develop our hypotheses we follow the constant comparative method advocated by Glaser and Strauss (1967). We focus on a 4 single well-known company, Amazon.com, and compare the reports written on it by the highest- valued Internet analyst, Henry Blodget, with those of maximally different rivals. We center on the financially volatile period of the so-called Internet “bubble” of 1998-2000 because it captures the problem of analysis under extreme uncertainty, and allows us to better understand how analysts might have contributed to the over-valuation of dot-com stocks. Our findings point to the existence of a previously undocumented phenomenon. Underlying the assessments made by each securities analyst, we found internally consistent networks of associations between categorizations, analogies and key metrics – what we label here calculative frames. For example, one particular calculative frame for Amazon included categorizing the company as an Internet company, seeing it as analogous to Dell Computers, and appraising its prospects in terms of its growth in revenues. Typically, this was associated with an optimistic view of the company. A contrasting frame was the view that Amazon was a book retailer, that it was analogous to Barnes and Noble, and that it should be valued on the basis of its current profits. Analysts who espoused this alternative frame tended to be pessimistic about the company. We find that these frames not only structure analysts’ position about companies, but are also robust over time, leading to sustained controversies among analysts over the value of the stock. Accordingly, we propose to see analysts as frame makers, specialized intermediaries that help investors attach numerical measures of value to stocks even in contexts of extreme uncertainty. The notion of frame-makers solves the puzzling inconsistency between theory and practice regarding security analysts, as it suggests one way in which analysts add value to investors despite their inaccurate price targets and money-losing recommendations. Our perspective contributes to the academic debate on analysts by reconciling and recombining the rather critical perspectives on analysts into a new and positive account of their 5 work. The notion of frame-making partly supports the neoclassic view of analysts by specifying the material tool that allows investors to engage in calculative decision-making in the presence of ambiguity and Knightian uncertainty. On the other hand, the notion of framing controversies runs counter to neoclassic notions of market efficiency, updating, convergence and unbiased forecasts: we find, for example, that two analysts with different frames can well react in opposite ways to the same piece of information on the very same day, and that these differences persist over time. Frame-making supports the neoinstitutional notion of imitation, as some analysts and investors make their decisions to adopt or abandon a frame based on what others do. Finally, frame-making extends Zuckerman’s (1999) cognitive view of analysts as passive classifiers by specifying the mechanisms they employ; on the other hand, it departs from it by stressing the tendency of successful security analysts to deviate from the herd. Our paper proceeds as follows. In the following section it reviews the vast academic literature written on analysts. Next, it
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