Study Finds School Ties Improve Analysts’ Accuracy
More evidence that it’s who you know that really matters: a new working paper* published by the Harvard Business School finds that sell-side analysts outperform on their stock recommendations when they went to the same university as a senior officer of the company. However, the authors also find that any advantage this might confer has beeen eradicated by Regulation FD, designed to impede selective disclosure.
“Exploiting novel data on the educational backgrounds of sell-side equity analysts and senior officers of firms,”the authors “test the hypothesis that analysts’ school ties to senior officers impart comparative information advantages in the production of analyst research.”
They test the data by “building portfolios that replicate sell-side analysts’ recommendations and by comparing how analysts perform on firms to which they have ties, relative to those firms to which they do not.”
Our main result is that equity analysts outperform on their stock recommendations when they have an educational link to that company. A simple portfolio strategy of going long the buy recommendations of analysts with school ties and going short the buy recommendations of analysts without ties earns returns of 5.40% per year in the full sample.
Rather than making the analysts overly sympathetic to their alma mater, school ties facilitate information sharing — or simply allow analysts to have a better insight into managerial quality — and thus provide analysts with school ties to a firm with an advantage over analysts of different educational backgrounds.
The study’s authors are able to use empirical techniques to distinguish between the two possible causal factors, and find that” agents in financial markets can gain informational advantages through their social networks.”
“In addition, laws designed to block these types of information pathways can be effective in curbing selective disclosure.”
Pre-Reg FD the return premium from school ties is 8.16% per year, while post-Reg FD the return premium is nearly zero and insignificant.
A similar test in the UK, which did not experience a change in the disclosure environment at this time, reveals a large and significant school tie premium for buy recommendations over the entire sample period, both pre- and post-2000.
Informal information networks are an important, yet under-emphasized channel through which private information gets revealed into prices, the authors conclude.
*”Sell Side School Ties” by Lauren Cohen, Harvard Business School; Andrea Fazzini, University of Chicago; and Christopher Malloy, Harvard Business School.
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March 14th, 2008 at 10:38 am
[...] to Research Recap this week enjoyed our post on school connections improving the accuracy of analysts’ stock recommendations. Too bad for those hoping for an insider edge: that pesky Regulation FD seems to have eradicated [...]
September 8th, 2008 at 12:28 pm
[...] The paper comes from the same authors who found that “school ties” improve analysts’ forecasts. [...]