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Stock analysts' influence on CEO dismissals keeps growing, despite dot-com scandals

August 1, 2008

For more information, contact: Benjamin Haimowitz,

Prominent among the many casualties of the dot-com bubble early in this decade were those whom many people held largely responsible for the debacle -- securities analysts themselves. Analysts and the banks for which they worked were subject to major litigation by New York State and the SEC, and the credibility of the entire industry was called into question.
What effect did this crisis in confidence have on the influence of securities analysts?
According to research presented at this week's annual meeting of the Academy of Management in Anaheim, the influence of analyst ratings actually increased in the wake of the scandals, at least so far as their effect on CEO dismissals by corporate boards is concerned.
"We found that the influence of analysts increased [after] new rules were adopted to assure analysts' independence," write the new study's authors, Margarethe F. Wiersema of the University of California, Irvine, and Yan (Anthea) Zhang of Rice University." In the post-2002 period, not only were boards more inclined to dismiss CEOs, but the influence of analysts on CEO dismissals also increased significantly."
The results came as something of a surprise to the professors.
"Given the crisis in confidence that the securities industry experienced, we expected to find that analysts' influence would have diminished," comments Prof. Wiersema. "Instead we found that the average rating that firms received from this group had more impact on CEO dismissals in  2003-2005 than it did in 2000-2002. Before the scandal, a CEO whose firm had a mean analyst rating of 2.7 (one point below our sample's average of 3.7 on a five-point scale) would have a 3% chance of being dismissed within six months; after 2002, that CEO would have a 7.9% chance of dismissal.
"What did diminish," she continues, "was the effect of negative analyst ratings in the post-scandal period. Pressure for analysts to provide more objective ratings led to a reduction in 'buy' or 'strong buy' ratings as well as a phenomenal increase in 'underperform' and 'sell' ratings, the total incidence of which increased from 1% to 9%. When those two negative ratings are a great rarity, they are obviously going to have more impact than they do when they are not so rare."
The findings emerge from an analysis of CEO successions in the S&P 500 companies during the six years 2000-2005. Two hundred thirty-nine CEO dismissals occurred in this period, of which 69, or 29%, were dismissals. The research explored the relationship between CEO successions and three measures of analyst ratings -- 1) the average rating among all analysts covering a firm during the six months prior to succession; 2) the average in the six months prior to succession compared to the average in the six months before that; and 3) the percentage of analyst ratings that were "sell" or "underperform" in the six months before succession.

As indicated, the professors found that lower ratings were significantly associated with a  higher likelihood of CEO dismissal in 2000-2002 and that this relationship became even stronger in 2003-2005.  Changes in average ratings and percentage of negative ratings were both significantly associated with dismissal in 2000-2002, but neither relationship was significant in 2003-2005.

CEO dismissals did not simply reflect weak performance in companies' stock prices and profitability: the effect of average analyst ratings in both periods was above and beyond these factors and exceeded each of them in impact.

Two years ago, in an analysis of CEO dismissals from 1996 through 2000, Prof. Wiersema reported to the Academy of Management that "whereas historically non-routine CEO turnover was a relatively rare event, increasingly the CEO has become a lightning rod of investor discontent...Given the importance of investment analysts in providing information to the financial community and the impact that their ratings and coverage have on firm stock valuation, it is not surprising that boards of directors listen and respond to the signals sent by investment analysts."

Boards of directors, this new research suggests, are listening and responding more than ever, a major intervening financial scandal notwithstanding.
The study, entitled "CEO Dismissal: The Role of Investment Analysts as an External Control Mechanism," was among several thousand research reports at the Academy of Management meeting. Founded in 1936, the Academy is the largest organization in the world devoted to management research and teaching. It has more than 18,000 members in 92 countries, including more than 10,000 in the United States. This year's annual meeting drew more than 9,000 scholars and practitioners to Anaheim, California from August 10th to 13th for sessions on a host of subjects relating to business strategy, corporate organization and investment, the workplace, technology development, and other management-related topics
Media Coverage: So that's why they always criticize stock analysts. (Friday, August 08, 2008).

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