New York, Feb. 7 (Reuters): Companies, which recruit investment bankers to serve on their boards, may not be doing their chief executives any favours.
A study shows that executives trading their own company's stock when there are bankers serving on their boards are likely to lose out on big gains. Their trades are, on average, not as profitable as those by executives whose boards have not tapped Wall Street bankers for members.
A research at the University of Michigan shows that insiders' profits from trading deteriorates in the years after a banker becomes a director. 'It decreases the advantage that insiders have, and information that was earlier privy only to them becomes public,' said Nejat Seyhun, a professor of finance at the university, who started the study four years ago.
Strategic company information that has not yet been publicised is probably passed on by the investment banker to other departments of that banker's financial services firm, such as the research department, according to Seyhun.
While the research only looks at the years from 1975-2000, analysts say that the results are relevant even today despite various corporate governance reforms.
'No matter how tight they make the Chinese wall, it always leaks,' said Jim Awad, chairman of Awad Asset Management, referring to the imaginary barrier between the investment banking and research divisions of financial services company.
The study of open market transactions by insiders in 509 firms shows that average annual profits of insiders fell to 1 per cent of their investment after an investment banker joined the board. That was down from 5 per cent in the years they didn't have the Wall Street executive on their board.
'What the study is saying about bankers on the board is that in some way the leakage of information deprives executives of the ability to manipulate their executive pay, which is a good thing,' said Beth Young, senior research associate at The Corporate Library, a corporate governance research group.
But investors and corporate watchdogs often view with suspicion the presence of investment bankers on the board of a company they provide services to.
'Company executives could benefit in indirect ways in terms of other business that gets done with the help of the investment banker,' said Michael Panzner, head of sales trading at Rabo Securities, who has written a book about the changing face of the stock market.
In one such controversy, regulators unearthed e-mails in which former Citigroup Inc CEO Sandy Weill, who was also a director at AT&T Corp, asked star telecom analyst Jack Grubman to reconsider his rating on AT&T. The e-mail was sent in 1999 around the time Citigroup was looking for the phone company's investment banking business, which it won.