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To a Startling Degree, Ratings of Stock Analysts Influence Whether Top CEOs Keep Their Jobs, Study Finds

August 1, 2006

For more information, contact: Benjamin Haimowitz,

In what seems a case of Main Street pushing back on Wall St., more and more companies are foregoing quarterly earnings guidance to stock analysts. In fact, recently the Business Roundtable Institute for Corporate Ethics and the CFA Institute of investment professionals called for the end of quarterly guidance entirely.

The pushback comes just as new research reveals that the influence analysts exert on chief executives has to do with a lot more than juggling financial numbers.

It has to do with whether CEOs keep their jobs.

The research, to be presented at the annual meeting of the Academy of Management (Atlanta, Aug. 13-16), suggests that stock-analyst ratings determine to a surprising extent whether boards dismiss company chiefs. The study estimates, for example, that if half the analysts covering a firm drop their rating one notch -- say, from "buy" to "hold" -- it increases by nearly 50% the likelihood the CEO will be dismissed within six months.

And this effect is not simply a reflection of a general downturn in company performance: it is above and beyond the effect of declining firm profitability or stock price and exceeds both of them in impact.

What is so startling about these results is that they run completely counter to the reasonable expectation that corporate directors will primarily be focused on the long term," comments Margarethe Wiersema of Rice University, who carried out the study with Mark Washburn of the University of California, Irvine. "Our findings suggest that boards are not focused enough on fundamentals and too focused on Wall Street."

It is not only a change of rating that can influence the fate of a prominent CEO; a decision by a brokerage to drop coverage can have a smaller but still significant effect. In the sample of firms studied (which, on average, were monitored by 16 analysts) a drop in coverage by one analyst increased the chance of CEO dismissal within a year by almost 40%.

"The irony about these results," adds Prof. Wiersema, who has studied CEO turnovers and successions extensively, "is that for a long time corporate boards tended to be too complacent about inferior executive leadership. Now the pendulum may have swung too far in the opposite direction, with boards so infected by Wall Street's restlessness that they pull the trigger on CEOs in the midst of a major shift in corporate strategy, even doing so when that strategy shift has been blessed by the board."

The study is based on an analysis of all CEO successions in Fortune 500 firms in the five-year period 1996 through 2000. On the basis of press accounts, the researchers judged 134 of the 233 turnovers during that time to be routine successions and determined 99 to be dismissals. Wiersema and Washburn then analyzed data on the following factors that might have affected whether the succession was routine or not:

-- the company's return on assets and total stock return in the year before the turnover;

-- stock analysts' average rating of the company's shares, on a five-point scale ranging from one (strong buy) to five (sell), in the six months prior to the turnover;

-- the change in the analysts' average rating in those same six months;

-- change in analysts' coverage -- that is, the number of analysts covering a company six months prior to succession compared to the number a year before succession.

The researchers found that declining stock returns and returns on assets significantly increased the probability of a CEO turnover being a dismissal, as did the average analyst rating in the previous six months and the change in the amount of analyst coverage in the six months prior to that. But the most powerful factor, above and beyond all of these, was the change in the average analyst rating in the six months before succession.

Prof. Wiersema acknowledges that in some instances analyst impatience with CEOs is well founded, and dismissal brings major improvements in company performance. "Quaker Oats and Banc One are two good examples," she says. "Both  made acquisitions that did not go well, and the boards proceeded to recruit CEOs who were experienced executives from the same industry and who improved the operational side of the business. In both cases, the companies ended up being bought at high valuations, and stockholders enjoyed a doubling of stock values."

But in other recent instances, she says, CEO dismissals have reflected short-term thinking that appears to be highly questionable.

"Newell Rubbermaid is a striking example," she says. "In January 2001, the board appointed Joe Galli, hailed as a marketing wizard, to turn a company that had never had a marketing/brand strategy into one that featured premium brands. That required a major upheaval in the company's operations, and, not surprisingly, Newell Rubbermaid's financial performance suffered and analysts lost patience. The board adopted the same short-term view, and early this year Galli left by mutual agreement."

Another example, she says, is Hewlett-Packard. "Obviously, Carly Fiorina's unique personality makes this a special case, but, as with Newell Rubbermaid, the CEO was embarking on a major redirection in company strategy requiring a long-term perspective. Here again, the lack of financial payoffs, so vexing to Wall Street, evidently led the board to take action, and here again the successor CEO has followed the same basic strategy as his predecessor. It leads one to question why the predecessor had to be let go, particularly when the stock is now up nicely without any real change in the company's course."

The paper, entitled "Investment Analysts, Market Signals, and their Impact on CEO Dismissal," will be among thousands of studies presented at the Academy of Management meeting. Marking its 70th birthday this year, the academy is the largest organization in the world devoted to management research and teaching. It has close to 17,000 members in 90 countries, including some 10,000 in the United States. This year's annual meeting will draw about 7,000 scholars and practitioners to Atlanta, Georgia, from August 13th to 16th for nearly 1,500 sessions on a host of subjects relating to corporate organization and investment, the workplace, technology development, and other management-related topics.

Media Coverage:
The Wall Street Journal. "Sell" = Fire: Analysts Views Cloud CEOs' Jobs. (Saturday, August 05, 2006).

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