In a post one year ago, we introduced our article on the previous lives of fund managers by an article accepted at the Review of Financial Studies. Naturally, not only fund managers can have previous lives – analysts may also have a past (insert scary music here) that gives them experience.
Industry Analyst Experience
In their 2017 Journal of Finance paper “Before an Analyst Becomes an Analyst: Does Industry Experience Matter?” Bradley, Gokkaya, and Liu examine a related question for financial analysts: How can analysts profit from industry knowledge when forecasting performance? To define experience, the authors first collect information on previous analyst employment (mainly from LinkedIn – a source we also use for research at our department). Analysts with at least one year of non-analyst work experience count as “experienced”. The experience counts as “related” to a specific firm the analyst follows if the previous employer and the firm have the same Fama-French industry classification code.
Does Analyst Experience Affect Performance?
Bradley and coauthors use the accuracy of an analyst’s earnings forecast as her performance. In detail, they compute the proportional mean absolute forecast error (PMAFE) as the analyst’s forecast error relative to the mean forecast error across all analysts minus 1. Hence, a negative value of PMAFE indicates above-average performance. To explore the relation between experience and performance, Bradley and coauthors run a linear regression with PMAFE as the dependent variable. The explanatory variables are a dummy for experience, for related experience, and for unrelated experience. Table 1 displays the regression results.
Table 1: Regression results for analyst forecast accuracy on previous industry experience. All coefficients are multiplied by 100 for ease of exposition. *** indicates significance at the 1% level. Source: Table 2, Bradley et al. (2017).
Table 1 shows that industry experience improves performance. Compared to analysts without experience, analysts with experience make forecasts that are 1.55% more precise (Model 1). However, analysts can only use their experience in related industries (Model 2, precision increase for experienced analysts in related industries -3.58%, compared to 0.76% in unrelated industries). Model 3 focuses on the subsample of experience analysts and confirms the results of Model 2: forecasts are significantly more precise for firms in related industries.
Analyst Experience and Career Outcomes
How do analysts profit from these more precise forecasts? Bradley and coauthors explore this question by looking at the analyst all-star ranking by the Institutional Investor (II) magazine. Apart from prestige, being an all-star analyst comes with a substantial financial benefit: a 61% earnings difference to non-star analysts. Table 2 shows the relation between all-star status (dependent variable) and industry experience (explanatory variable).
Table 2: Regression results for all-star status in the previous October Institutional Investor magazine on previous industry experience. All coefficients are multiplied by 100 for ease of exposition. *** indicates significance at the 1% level. Source: Table 2, Bradley et al. (2017).
The ods of becoming an all-star analyst are significantly higher for experienced analysts (Model 1), and only following a firm in a related industry is helpful (Model 2 and 3).
How Valuable Are Experienced Analysts?
In summary, the results of Bradley and coauthors indicate that previous work experience matters for analysts as well as for fund managers. Beyond improving performance, it leads to individually more favoable career outcomes, and reduces informational asymmetry between investors and firms.
How valuable is being covered by an experienced analyst to a firm? Bradley and coauthors show that stock prices react more strongly to forecast revisions by experienced analysts, and that not being covered by such an analyst any more results in stock price drops. A potential reason for this effect is information asymmetry: Financial markets believe that experienced analysts create more (or more reliable) information. Losing coverage through such an analyst therefore increases the information asymmetry between potential investors and the firm.
Take-away: Experience matters!
In summary, the results of Bradley and coauthors indicate that previous experience matters for analysts as well as for fund managers. It improves performance, leads to more favorable career outcomes, and reduces information asymmetries between investors and firms. So: Go, Industry Newbies!