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Study Exposes Stock Analysts as Fashionistas

August 1, 2008

For more information, contact: Benjamin Haimowitz,

Who drives the seemingly endless succession of fads and fashions that have become staples of contemporary management?
Business professors, management consultants, assorted gurus, and business journalists have been the usual suspects. But now a new study implicates one more group that until now has largely escaped scrutiny in this regard -- security analysts.
Research presented at the 2008 annual meeting of the Academy of Management finds that "professional observers of the capital market, such as analysts, are an important part of the management-fashion community too. [Our research] suggests that analysts are facilitators or even originators of management fashions."
This discovery evokes disapproval from the study's authors, Ann-Christine Schulz and Alexander T. Nicolai of the University of Oldenburg. Analysts, they suggest, should serve as "a corrective mechanism that limits the dissemination of strategy fashion." If, instead, they assume the role of facilitators, their judgments, "particularly when a management fashion is at its zenith...can mislead top managers into overestimating the virtues of popular strategies...This effect promotes faddish behavior and restricts a manager's chances of pursuing unique strategies."
To explore the analyst-fashion relationship, Schulz and Nicolai did what no one has likely done previously -- investigated in depth the role analysts played in perpetuating a major management trend -- specifically, the massive corporate-refocusing wave set off in the 1990s by the concept of core competence. 
Core competence, the central message of which is that companies should orient themselves to their core business and strive for "competence leadership", succeeded the concept of unrelated diversification (or conglomeration) that dominated the corporate world for two decades. Such was the popularity of core competence that the number of articles in the business press concerning the new fashion increased from 10 in 1990 to a high of 600 in 2000.
Drawing on large databases of North American manufacturing firms, Schulz and Nicolai analyzed the relationship between company refocusing initiatives or diversifying initiatives during the period 1990-2002 and what they call "analyst surprise," a measure reflecting the difference between analysts' average  forecasts of company earnings and actual results three years later. They found that analysts overestimated company earnings in general; but they overestimated earnings considerably more for refocusing firms (companies that reduced the number of their businesses and the amount of unrelatedness among their businesses) than they did for similar companies that did not change their structures. The researchers also found a positive relationship between the volume of articles on core competence at the time of companies' refocusing and analysts' overestimation of those companies' earnings.
To the authors' surprise, however, analysts did not evince a tendency either to overestimate or underestimate the future earnings of firms that diversified, despite the fact that the predominant fashion was the opposite of diversification. "We can conclude," they write, "that, as a matter of principle, analysts did not differentiate between diversifying firms and firms without M&A activities during this period."
Beyond serving as fashion facilitators, analysts may even play an important role as fashion originators, Schulz and Nicolai suspect. "Managers already faced pressure from security analysts and investors to de-diversify before the core-competency fashion appeared," they observe. "A clear-cut alternative arose [among analysts] to replace the firm-as-portfolio model. In this perspective, the core-competence concept resembles the ex-post rationalization of a management technique demanded by the capital market, rather than a managerial innovation."
And perhaps, after all, it is not so surprising that analysts are the fashion promoters this study suggests they are. As the authors note, "Many analysts can boast MBA qualifications earned at elite business schools but can provide little actual experience in business practice. Most MBA programs are conceived around the idea that management studies provide vocational skills. As such, their graduates are likely to have a strong leaning toward rule-bound behavior and a natural tendency towards standardized solutions sets of management fashions."
The study, entitled "Are Security Analysts Fashion Victims? -- The Core-Competence Case," 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:
Financial Times. Beware of fad-loving analysts. (Tuesday, August 19, 2008).

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