Rich Gentry
OXFORD, Miss. – So-called “star analysts” have great power over stock prices, a University of Mississippi professor and director of the Center for Innovation and Entrepreneurship has discovered.
Richard Gentry, an assistant professor of entrepreneurship and strategy, worked on the study with Steven Boivie, of Texas A&M University, and Scott D. Graffin, of the University of Georgia. Their findings shed light on the importance of “star analysts.”
These analysts’ opinions on certain investments can cause changes in valuations for stocks, and usually those opinions with the investing public outweigh the reputations of the CEOs running the companies being evaluated by the analysts.
“This study examined how people interpret information when they are confronted with sometimes conflicting sources,” Gentry said. “CEO reputation was only influential in influencing the market reaction to downgrades when the analyst making the downgrade did not have a strong reputation.”
The team’s paper, “Understanding the Direction, Magnitude, and Joint Effects of Reputation when Multiple Actors’ Reputations Collide” is in the February-March issue of the Academy of Management Journal. The peer-reviewed publication is published every other month by the academy, which, with more than 18,000 members in 123 countries, is the largest organization in the world devoted to management research and teaching.
The business world has a number of star CEOs. There are many publications devoted to leadership each year, and American companies spend an estimated $14 billion per year on grooming leaders. This might give the appearance that a CEO’s reputation for superior leadership would prove dominant over the best analysts, but the study found the opposite.
“A downgrade by a star analyst causes tremendous valuation changes, which are not offset by the CEO’s reputation,” the study finds. ” … CEO reputation buffers the stock market reaction to downgrades by regular analysts, but, when a downgrade is issued by a star analyst, the CEO’s reputation has almost no effect on the market reaction.”
The study draws on large databases of corporate, financial and market information compiled over a 13-year period. CEO reputation is determined by the number of leadership awards bestowed on a chief over the five years leading to a given year by seven leading business magazines.
The team studied the stock market’s reaction to a downgrade by a star analyst, particularly someone ranked among the top one-sixth or thereabout. They found those downgrades led to an average market-adjusted, two-day decline of a stock of 3.5 percent to 3.6 percent, whether the CEO had won as many as five prestigious leadership awards over the previous five years or had been honored with one or two or none at all.
In marked contrast, the impact of a downgrade by analysts outside that select circle varied considerably, depending on the reputation of the CEO.
While leading to an average market-adjusted decline of 1.93 percent for firms headed by five-time leadership honorees, it produced a 2.74 percent decline for those headed by non-honorees, a drop of 42 percent more.
In contrast, the mean response to upgrades, improvements in the ratings, by nonstar analysts ranged from 1.86 percent for firms with five-time-honoree CEOs to 2.29 percent for companies of nonhonorees, a 23 percent greater boost for the latter group.
Why do firms of pedestrian CEOs receive this significantly greater bump when their ratings go up? The study explains, “Increased expectations for future performance will cause shareholders to react less positively to upgrades by analysts because their expectations that star CEOs will continue to deliver high levels of performance are already reflected in the firm’s value.”
CEOs who had received one or more awards generally elicited more recommendation changes than others, the study also found. The professors speculate this may be attributable to analysts’ seeking to “garner attention.”
At the same time, having a large number of CEO awards decreased the number of downgrades a firm received by star analysts. The two findings lead the authors to observe that “firms led by star CEOs receive greater scrutiny in general … but CEO reputation may offset that scrutiny for star analysts.”
Gentry, noting the findings of star analysts causing dramatic market shifts and their being more likely to issues recommendations, suggested that it may be worth reconsidering which types of firms they’re assigned to analyze. Markets could function more effectively if these influential analysts are distributed more evenly across all kinds of firms, he said.
“Instead of having so much insight and influence clustered around a relatively small number of the sexiest firms, maybe that talent can be of more service covering a more varied group,” said Boivie, one of the study’s authors. “Instead of having three or four all-stars covering Google or Apple, maybe we could do as well with one or two.”