When stars collide: CEOs versus analysts

Leadership is big business: US companies reportedly spend $14 bn a year to teach it, according to a Bersin by Deloitte study, and there are reams of literature devoted to it. But while the idea of a ‘star CEO’ is nothing new, one group of researchers wanted to look at how the reputation of a top CEO compares to the power of a ‘star analyst’.

‘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,’ explains Steven Boivie of Texas A&M University, who conducted the research with Scott Graffin of the University of Georgia and Richard Gentry of the University of Mississippi, in a press statement.

‘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,’ he adds.

Drawing on corporate, financial, and market information compiled over a 13-year period, the study authors assessed CEO reputation by looking at the number of leadership awards bestowed on a chief executive over the previous five years by seven different business magazines.

‘Star’ analysts were then identified through their selection to one of the all-American teams published each year by Institutional Investor magazine – a group that constitutes around 17 percent of analysts, according to the press statement.

The study then looked at a total of about 19,500 downgrades and 17,400 upgrades each consisting of a change of one point or more in recommendations, ranging from one, being ‘strong buy’, to five, being ‘strong sell’.

The power of a top analyst

What the researchers find is that while ‘CEO reputation buffers the stock market reaction to downgrades by regular analysts, when a downgrade is issued by a star analyst, the CEO’s reputation has almost no effect on the market reaction.’

In fact, ‘a downgrade by a star analyst causes tremendous valuation changes,’ they write, ‘which are not offset by the CEO's reputation.’

Specifically, the stock market’s reaction to a downgrade by a star analyst led to an average, market-adjusted, two-day decline of a stock by 3.5 to 3.6 percent – regardless of whether the CEO had won as many as five prestigious leadership awards over the previous five years, had been honored with one or two or even none at all.

When it comes to downgrades by analysts outside that select circle however, CEO reputation had a bigger – and more varied – impact. Firms headed by five-time leadership honorees facing a downgrade from a standard analyst saw a decline of 1.93 percent decline – compared to a 2.74 percent drop at companies led by non-honorees – ‘presumably run-of-the-mill types’.

The impact of an upgrade

Looking at upgrades, rating changes by star analysts had the greatest impact on the market. And again, ‘the market response to star-analyst changes was about the same no matter the number of awards garnered by CEOs,’ according to the press release. The average market-adjusted response to upgrades by top analysts was between 3.27 percent and 3.29 percent – ‘whether the CEO was a non-honoree or a five-timer’.

Interestingly though, upgrades from non-star analysts at firms headed by non-honorees was bigger than at those companies with a star CEO (1.86 percent and 2.29 percent respectively).

Why do firms of ‘pedestrian CEOs’ receive this significantly greater bump? ‘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,’ explain the researchers.

The researchers also found ‘firms being covered by star analysts received more upgrades and downgrades’. This 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.’

Given their ability to move markets, the researchers suggest that having these ‘influential analysts’ spread more evenly across different firm sizes and types could result in more effective markets.

‘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,’ says Boivie. ‘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 published in the February/March issue of the Academy of Management Journal