Many in the investment-banking industry believe that the recent Wall Street settlement¹ brings to an end the most difficult part of the overhaul of equities research. This could not be further from the truth. For reasons that go well beyond the legal and reputation issues, the research business is fundamentally sick.

Simply put, the research arms of the big investment banks are far too expensive given the structural decline in margins in the equities business. They urgently need to deliver more relevant, more original, and better-targeted research. While some analysts have provided company analysis that is useful enough to justify the cost, these individuals remain the exception.

Quite rightly, most attention will be paid in the short term to complying with the new settlement regulations and ensuring that the necessary firewalls are in place. But in the long term, if reputations are to be restored, investment banks have to provide a better product at a lower cost. They can do so by making the following changes.

• First, by moving from stars to teams. The cult status gained by many analysts in the bubble years is not only discredited; it is also too expensive. The star system will need to be replaced by a "professional-services-firm" model of teams of people working in a more disciplined fashion. This is easy to say but devilishly hard to do.

  Up to now, analysts have been compensated and promoted according to the amount of new investment-banking business they have brought in and to their rankings among institutional investors. Investment banks will now have to focus more closely on the value analysts provide to their clients, by monitoring things such as the long-term record of their investment recommendations.

• Second, by moving from distributing uniform reports widely to producing tailored research. Hundreds of standard company and industry reports are blasted out each month, only to be left unread by the typical fund manager. But the needs of large institutions with their own analysts are different from those of hedge funds, small insurance companies, and retail investors. Research will have to be more closely tailored to each investor segment.

• Third, by shifting from providing information to insight. While good analysts have always provided original ideas, far too many researchers have based their jobs on packaging and massaging information. But the appeal to investors of simple information has been limited by the coming of the Internet and the passing of Regulation FD (fair disclosure), which bars companies from leaking information selectively through analysts. That means undertaking much more in-depth work to generate fresh ideas.

  Research will now have to include proprietary views on how different industries will evolve and how that will affect each company. An investment bank will have to show how a company is perceived by its customers and to analyze its balance sheet better. Given the expense of this type of fundamental research, investment banks will have to be more selective about the number of companies—and the number of industry subsectors—that their analysts cover.

• Fourth, by moving from "make your own" research to outsourcing. Most research arms of investment banks are now fully integrated: they collect data, build models, and produce investment recommendations. But much of the data collection work could be done more cheaply in developing countries such as India. In addition, investment banks will have to form research partnerships with boutique consulting groups, specialized data providers, and others. That will allow the banks to provide insight without having to foot the entire bill.

As practices change, so will the industry’s pricing model. Investment research has traditionally been bundled with equities sales and trading as a single service. A variety of new pricing models is bound to develop. In some cases, research will be charged for separately. In other cases, there will be tiered pricing for research, based on the amount of research and other services that an investor wants. Three tiers are likely to evolve: "research light," for smaller clients; "bespoke research," for larger clients; and the fully tailored offer.

We believe that developing more relevant and objective research at lower cost is not only possible but also a financial imperative. Now that the settlement is over, the real work begins.