Authors: DANIEL BRADLEY, SINAN GOKKAYA, and XI LIU
Journal: THE JOURNAL OF FINANCE • VOL. LXXII, NO. 2 • APRIL 2017
Link: Bradley et al. (2017)
#What is the Research Question? :
Despite the widespread view that industry knowledge is critical to an analyst’s job, there is little evidence that directly and systematically ties industry knowledge to analyst performance. Although industry knowledge is in itself difficult to measure, the following research questions were addressed.
When covering stocks within their industry expertise:
(1) Do analysts with industry expertise and knowledge provide more accurate earnings forecasts?
(2) Are there differences in the market response to earnings forecast revisions from industry-experienced and industry-inexperienced analysts?
(3) When stock coverage is terminated for the industry experienced analysts, are there differences in price effects, bid-ask spreads, liquidity, volatility around earnings announcements and earnings surprises for those stocks, versus inexperienced analysts?
(4) Does industry experience lead to more positive career outcomes for stock analysts?
#What is the Academic Insight? :
(1) YES. The earnings accuracy of forecasts by analysts with industry experience is significantly better than that of analysts without industry experience. The average forecast accuracy is 3.6% higher, after controlling for task difficulty, general and firm-specific forecasting skill, brokerage house prestige and other factors that explain differences in earnings forecast accuracy.
(2) YES. The market reaction to either upward or downward revisions in earnings estimates is larger for experienced versus inexperienced analysts, after controlling for the relevant analyst specific variables.
(3) YES. Using measures such as bid-ask spreads, illiquidity, and volatility and other measures of information uncertainty, increase post coverage-termination events by experienced analysts. Price impacts are also significantly lower (77bps) for stocks that lose experienced analyst coverage around the termination date. Further, a portfolio of industry experienced analysts’ buy and sell recommendations were found to outperform a similar portfolio consisting of inexperienced analyst recommendations.
(4) YES. Previous work experience increases the odds of being elected to “all-star” analyst lists by 75%, when the analyst covers stocks related to the his/her industry experience.
#Why Does It Matter? :
Using novel biographical data on sell-side analysts, this study explores their previous employment history to examine how industry employment and experience in related and unrelated industries influences earnings forecasts, career outcomes, and market responses to earnings revisions and coverage terminations.
The evidence presented in this study is consistent with the view that previous industry work experience provides analysts with a fundamental understanding of the industry. Consistent with the strong emphasis that buy-side institutions and sell-side analysts continue to place on industry knowledge, the findings also support the idea that the market places greater importance on research produced by analysts with industry expertise.
Interestingly, the study finds that the constraints associated with Regulation FD do not affect these conclusions. Industry experience matters in the pre and post Reg FD periods and the strength of the economic and statistical impact of industry experience on performance is unaffected by the passage of Reg FD.