Courtesy of Shawn Huang
Organizational outcomes have long been known to be, at least in part, determined by executives’ idiosyncratic characteristics. Prior research shows that Chief Executive Officers (CEOs) and Chief Financial Officers (CFOs) uniquely impact corporate practices and operations. Peering into these effects, recent studies examine executive heterogeneity with respect to aspects such as education, personal characteristics, and career experience (Bamber, Jiang and Wang 2010; Custódio and Metzger 2013; Benmelech and Frydman 2015; Law and Mills 2017). The thrust of these studies is to tie general experience or traits to operational outcomes and corporate policies. For example, a background in the military service leads to more conservative investment (Benmelech and Frydman 2015) or tax planning (Law and Mills 2017).
In a recent paper titled, “Career Experience and Executive Performance: Evidence from Former Equity Research Analysts,” we depart from this line of research in that we focus on specific experience. In particular, we investigate whether skill sets developed during formative years carry over and meaningfully impact top executive performance with respect to related tasks. We investigate this question by assembling a sample of CEO/CFOs who have prior work experience as equity research analysts.[1] The equity research industry provides an excellent setting to address the importance of early career skill sets for several reasons. First, many career paths leading to top executive positions such as marketing, legal, and engineering are heterogeneous in nature. For example, a marketing executive might be involved in sales, advertising, media strategy, or brand development; each one of these paths providing very different training and experiences. In comparison, forecasting earnings performance and valuing companies are standard features of the equity research analyst job. Second, forecasting and stock selection are not only standard, they are performed quite frequently and benefit from objective performance benchmarks in the form of earnings announcements and realized stock performance. Third, for the overwhelming majority of jobs leading to a top executive position, it would be impossible to quantify past performance due to both data availability and the inherent lack of easily measurable outputs. At least for part of our sample, we can accomplish this, and hence are able to compare former analyst CEO/CFOs’ past performance with their current performance on related tasks. Overall, the equity research setting permits us to investigate the transfer of skill sets from past job experience, in addition to providing insights into the specific transition from equity research to a top executive position.
To identify former equity analysts, we begin with the BoardEx database from 1990 to 2017 and retrieve CEO/CFOs with prior employment listed as an ‘analyst’. We narrow this to equity research analysts by manually checking for either buy-side or sell-side analyst experience with the following sources: LinkedIn, Bloomberg, Morningstar, Brokercheck, and The Wall Street Journal. Our final sample of equity analysts have, on average, six years of work experience as either a sell-side or buy-side research analyst.
Consistent with career experience in earnings forecasting, we find former analysts provide earnings guidance that is more accurate than that of other executives, controlling for standard factors that explain cross-sectional differences in guidance accuracy. In terms of economic significance, the earnings forecasts provided by former analysts are 27.2% more accurate than those of other executives. This is an important finding since management earnings forecasts are heavily relied on by market participants, explaining greater return variance than such disclosures as earnings announcements, analysts’ forecasts, and SEC filings (Ball and Shivakumar 2008; Beyer, Cohen, Lys, and Walther 2010).
Equity analysts value and recommend stocks based on fundamentals, as well as an assessment of industry growth potential and the management team (Groysberg, Healy, Nohria and Serafeim 2012). We conjecture this experience should aid CEO/CFOs in valuing an acquisition and evaluating the target’s management, both of which are critical steps in the acquisition process (Bruner and Perella 2004; DePamphilis 2019). To evaluate M&A performance, we obtain a sample of 7,981 U.S. acquisitions. Within this sample, former analyst CEO/CFO-led acquisitions represent a total of $110 billion in M&A deals, comprising about 2.5% of the total deal value. We find former analyst-led acquisitions are associated with abnormal return premiums to acquisition announcements between 1.1% and 1.2% larger than those of other executives. In economic terms, this translates to between $133 and $146 million in additional shareholder value for the average former analyst-led acquirer.
For a subset of these CEO/CFOs, we can trace their forecasting and stock picking performance histories. Similar to the level of experience we observe based on our original hand-collection, these analysts average 6.8 years in the IBES database. We categorize their earnings research record as ‘better’ if their earnings forecast accuracy record is superior to that of the median analyst; we define their stock recommendation record in the same fashion. The results indicate a positive association between a record of better earnings forecasting and more accurate current earnings guidance, as well as a positive association between better stock recommendation profitability and current M&A success.
In addition to forecasting earnings and recommending stocks, equity analysts are frequent participants in earnings conference calls. We posit this experience should help executives prepare for earnings calls and navigate the interaction with call participants. Conference calls are an important event to investigate since they represent a significant disclosure channel for management and provide market-relevant information beyond that of earnings announcements (Bowen, Davis and Matsumoto 2002; Chen and Matsumoto 2006). Consistent with earnings call experience, we find former analyst executives provide greater certainty in their answers to conference call questions. This beneficial effect is economically meaningful in that executives with analyst experience provide 13.3% more certain answers than do other executives. Moreover, this effect is especially pronounced when former analyst executives are asked forward-looking questions.
Given the evidence of performance advantages in specific settings, a natural question to investigate is how former analysts’ firms perform overall. This is an empirical question since better performance on these tasks—guidance, M&A, and conference calls—certainly does not guarantee better overall firm performance. We examine annual measures of firm performance, including an accounting measure of performance (return on assets), and three- and four-factor adjusted stock return measures, finding evidence consistent with former analysts’ firms exhibiting superior performance. In terms of economic impact, top executives with analyst experience generate a $64 million higher net income, on average, and improve shareholder value by between $122 and $150 million compared to other executives.
Our paper contributes to the broader literature in accounting and finance that examines the impact of top executives’ human capital on corporate performance outcomes (e.g., Bertrand and Schoar 2003; Malmendier and Tate 2009; Bamber et al. 2010; Dyreng et al. 2010; Law and Mills 2017). Different from these studies, our interest is in whether specific forms of experience appear to carryover to top executive performance for related corporate functions. This is important for at least two reasons. First, our findings may inform market participants in general and corporate boards in particular—especially, those in need of specific expertise—that in some settings, there appears to be a transference of unique skill sets from earlier careers to top executive positions. For instance, our finding that former analyst executives provide more accurate earnings guidance should be of interest to investors and analysts, who rely on this information to form their own performance forecasts and investment strategies. Furthermore, our finding that former analyst executives lead successful M&As should be of interest to stakeholders since M&As represent an important but complex form of corporate investment (Moeller, Schlingemann and Stulz 2005).
Second, although there is a well-developed literature examining general career backgrounds, ultimately, individuals tend to select into certain initial careers such as military service, accounting, etc. Hence, when evaluating operational or policy outcomes, it is very difficult to disentangle the effects of the CEO/CFOs’ general background experiences from their innate characteristics. Our setting focuses on a former career with aspects that are fairly standard such as forecasting, valuation, and conference call interaction. Since these skills are arguably more likely a result of on-the-job experience, it allows us to provide some evidence on the debate between the importance of experience versus inherent traits for performance outcomes (e.g., Bertrand and Schoar 2003; Adams, Keloharju, and Knupfer 2018).
[1] We examine CEOs and CFOs as a combined group representing companies’ top executives. For ease of exposition, we refer them as ‘CEO/CFOs’.
