In a previous post, we discussed differences between male and female fund managers, and gender bias in mutual funds. However, not only investors suffer from biases. And today, we consider equity analysts.
In their paper 2019 “In-Group Bias in Financial Markets”, Jannati, Kumar, Niessen-Ruenzi, and Wolfers analyze the impact of group-based social biases on analyst forecasts. The main idea of the paper is that sell-side analysts are more favorable to firms with CEOs of their own “type”. And reversely, analysts underestimate CEOs who do not belong to their in-group.
One analyst, different groups
Clearly, there are different ways to define an analyst’s “type”. Jannati and coauthors consider groups based on gender, ethnicity, and political orientation:
- They determine gender as male or female using the analyst’s and CEO’s name. (16.7% of analysts and 4.7% of CEOs are female.)
- Ethnicity is coded via a dummy variable “foreign”. To determine whether a name is foreign, the authors use a random sample of workers from Amazon Mechanical Turk who classify whether a name sounds foreign. Names with 75% foreign classification give “foreign” a value of one, and zero otherwise.
- Political orientation is identified using financial contributions to Democratic- and Republican-affiliated candidates and party committees in political campaigns.
In-group bias and earnings surprises
Jannati and coauthors first analyze whether earnings surprises are affected by whether the CEO and analyst gender differ. In case of in-group bias, earnings surprises (defined as the absolute value of actual earnings minus consensus forecast relative to stock price) should be smaller for the in-group: male analysts will underestimate female CEOs more than female analysts. Hence, positive (negative) earning surprises will be greater (smaller) for male than for female analysts. Table 1 shows the results separately for positive (panel A) and negative (panel B) earnings surprises. The main independent variable is a dummy variable that equals one if the CEO is female, and zero otherwise.
|Table 1: In-group bias and earnings surprises|
|Male analysts||Female analysts|
|Panel A: Positive earnings surprises|
|Female CEO * Reg FD||0.163**||-0.101|
|Panel B: Negative earnings surprises|
|Female CEO * Reg FD||-0.073**||0.356***|
*** and ** indicate significance on a 1 % and 5 % level. Source: Table 3 and 4 from Jannati et al. (2019).
Panel A of Table 1 shows that male analysts have larger positive earnings surprises for firms with female CEOs than for firms with male CEOs (column 1). Similarly, female analysts have significantly smaller earnings surprises for female CEOs (column 3). Panel B repeats the analysis for negative earnings surprises. Again, the signs are consistent with in-group bias.
Alternative explanation: Information
Column 2 and 4 add an additional variable: the interaction between the CEO gender dummy and Reg FD (Regulation Fair Disclosure). The intuition is that male CEOs might prefer to disclose information to male analysts, as they are part of their in-group. In this case, differences in earnings forecast would be due to different information instead of bias. However, the results remain significant in 3 out of 4 cases.
Ethnicity and political orientation
The result for gender holds for ethnicity and political orientation as well: Republican analysts underestimate Democratic CEOs (and vice versa), and US analysts underestimate foreign CEOs. Overall, the results show earnings surprise patterns consistent with the in-group bias hypothesis for all three demographic dimensions.
Does the market know?
In a world with rational investors, analyst biases should be taken into account by investors. Hence, stock prices should react less to positive earnings surprises by firms with “out-group” female CEOs – since analysts (who are predominantly male) underestimate these. To check this, the authors analyze whether cumulative abnormal returns for female CEO firms are less sensitive to earnings surprises. But quite to the contrary: Equity markets react more to positive earnings surprises by female CEOs. Hence, investors are either unaware of analysts’ in-group bias – or share them.
Take-away: Underestimating CEOs increases price volatility
To summarize, equity analysts and investors underestimate firms that are headed by minority groups. This leads to inefficient information processing and distorted prices.