When star CEOs collide with star analysts, the analysts prevail, new study finds
March 31, 2016
For more information, contact: Ben Haimowitz , (718) 398-7642, firstname.lastname@example.org
What happens when the romance of corporate leadership collides
with the romance of stock analysis? With a massive literature devoted to
leadership and American companies reportedly spending $14 billion a year to
teach it, one might expect a CEO's reputation for superior governance to prove
dominant over even sharp-eyed analysis. Yet, some new research finds otherwise.
According to a study in the current issue of the Academyof Management Journal, "a downgrade by a star analyst causes
tremendous valuation changes, which are not offset by the CEO's
reputation....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."
In short, "star analysts' reputation is more powerful when it
comes to how the market reacts to downgrades, even when star analysts are
downgrading firms run by star CEOs."
Specifically, the researchers found the stock market's reaction to
a downgrade by a star analyst (someone ranked among the top one sixth or
thereabouts of the breed) led to an average market-adjusted, two-day decline of
a stock of 3.5 to 3.6% 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% for firms
headed by five-time leadership honorees, it produced a 2.74% decline for those
headed by non-honorees (presumably run-of-the-mill types), a drop of 42% more.
Comments Steven Boivie of Texas A&M University, who conducted
the research with Scott D. Graffin of the University of Georgia and Richard J.
Gentry of the University of Mississippi, "there has been much
documentation of the advantages a firm enjoys when the CEO has a reputation for
excellent leadership (an advantage our study confirms), but little research has
been done on how this plays out in interactions with highly reputed others.
We've all heard about the romance of leadership, a belief verging on mysticism
about what great chief executives can lead companies to achieve. But, although
we don't hear quite as much about it, there's also a romance of stock analysts,
who, as Harvard's Boris Groysberg informs us, have been variously described by
seasoned investors as 'Diogenes with a lamp' or 'a Renaissance man' or a
'course fixed on truth.' Our findings suggest that the romance of analysis
exceeds the romance of leadership, at least where the investment community is
The researchers found a pattern among upgrades that was a somewhat
reduced mirror image of the pattern for downgrades. Once again, rating changes
by star analysts had the greatest impact on the market. And, once again, the
market response to star-analyst changes was about the same no matter the number
of awards garnered by CEOs, the average market-adjusted response to their
upgrades being between 3.27% and 3.29% whether the CEO was a non-honoree or a
In contrast, the mean response to upgrades by non-star analysts
ranged from 1.86% for firms with five-time-honoree CEOs to 2.29% for
companies of non-honorees, a 23% greater boost for the latter group. Why do
firms of pedestrian CEOs receive this significantly greater bump? As the
professors explain, "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."
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 in the five years
previous to a given year by seven leading business magazines. Analyst
stardom is gauged by selection to one of the all-American teams published
annually by Institutional Investor magazine through worldwide
surveys of money managers at large investment and hedge funds, a select group
that constitutes about 17% of analysts. The study's total of about 19,500
downgrades and 17,400 upgrades each consisted of a change of one point or more
in recommendations that ranged from 1/strong buy to 5/strong sell.
As would be expected, the researchers controlled for many factors
that can influence the effects of changed recommendations, including those
related to analysis (such as extent of analysts' experience or number of a
firm's upgrades or downgrades in the prior two weeks); those related to firms
themselves (such as size, diversification, past profitability, and percent of
institutional ownership); and those associated with company management (such as
board size, CEO duality, and CEO tenure).
CEOs were recipients on average of 1.25 prestigious awards for
leadership over five previous years, the study reveals. For the entire sample,
each prior award reduced market reaction to a downgrade by an average of 3% and
(because of higher market expectations for superior leadership) reduced reaction
to an upgrade by 4%. In addition to finding that recommendation changes by star
analysts amplified changes in market response compared to those resulting from
changes by non-stars, the professors found that "firms being covered by
star analysts received more upgrades and downgrades," a finding that
suggests that "star analysts may simply have more discretion in changing
the recommendations they issue, and may also have a greater incentive in making
changes in order to maintain their recommendation's accuracy."
It was also discovered that firms led by CEOs who had received one
or more awards generally elicited more recommendation changes than others,
which, the professors speculate, 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."
In conclusion, the authors wonder if, given that "star
analysts move markets dramatically and are generally more likely to issue
recommendation changes...it might be worthwhile [re]considering to what types
of firms they are assigned. Markets may function more effectively if these
influential analysts are distributed more evenly across all firm sizes and
Adds Prof. Boivie: "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. Instead of having
three or four all-stars covering Google or Apple, maybe we could do as well
with one or two."
The paper, “Understanding the Direction,
Magnitude, and Joint Effects of Reputation when Multiple Actors' Reputations
Collide” is in the February/March issue of the Academy ofManagement Journal. This 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 Academy's other publications are Academy
of Management Review, Academy of Management Perspectives, Academy of
Management Learning and Education, Academy of Management Annals, and Academy
of Management Discoveries.