When analyst attention is absorbed by CEO turnover, other companies in their portfolio pay the price, new Cornell research finds.
The study, "Analyst Rational Inattention: Evidence from CEO Turnover Events," published early access on Feb. 16 in the Accounting Review, finds that high-impact turnover events capture a disproportionate amount of analyst attention, leading to less-accurate forecasts for non-event companies they cover during that time.
"The sell-side analyst profession is a very relational job," said lead author Thomas Godwin, professor of practice in the Charles H. Dyson School of Applied Economics and Management in the Cornell SC Johnson College of Business. "Analysts need to get acquainted with company policies, company goals and a firm's approach to day-to-day decisions that affect financial statements. Whenever you have a different CEO enter, even if it's very expected turnover, you know that the style is going to change."
Rebuilding relationships with executive leadership takes time, and the transition to a new decision-making structure demands extra attention when calculating strategic change, risk and future earnings. These conditions leave limited cognitive resources for non-event companies, making their forecasts 1.15% less accurate, equivalent to the analyst losing four years of general forecasting experience.
"Analyst literature has been pretty consistent with the consequences of limited attention," Godwin said. "It leads to companies making value-destroying acquisitions, cutting dividends, granting opportunistic CEO stock options and having poor stock returns, which are certainly very significant consequences."
The research team, including co-authors Theodore H. Goodman of Purdue University and R. Christopher Small of the University of Houston, analyzed a sample of 876,385 forecasts to track analyst attention trends during CEO turnover.
The results suggested that analysts reallocate their attention deliberately, influenced by career incentives. This behavior is known as rational inattention, an economic theory pioneered by Christopher Sims, professor of economics at Princeton University - the conscious decision to focus limited cognitive resources to a place of greater priority.
In support of this theory, the study shows that analysts prioritize larger companies, which stands to offer them greater career benefits. Conversely, this means sacrificing accuracy for the smaller companies in their portfolios. When an analyst is handling a CEO turnover event, non-event companies with below-median market value of equity (MVE) saw a 1.75% increase in inaccuracy, while non-event companies above-median MVE did not see a significant change in accuracy.
Godwin's study also shows that rational inattention during CEO turnover is consistent across junior and senior analysts, corroborating the idea that these choices are intentional, not a rookie mistake.
"Anyone who is working hard needs to make trade-offs in terms of where they exert their effort and attention," Godwin said. "Our research shows that you should be able to expect that where they devote their effort is consistent with their incentives."
The limits of analyst attention are likely inevitable, Godwin said, even with shifts in company policies or analyst behaviors. But if companies can acknowledge these constraints, they'll be able to make better-informed decisions for their businesses.
"Individual time constraints shape information production in capital markets, and I think that has pretty broad consequences," Godwin said. "Information production isn't always just the quality of the inputs; it's affected by the intermediaries and their limitations. I think that's something we need to be more aware of."
Nina Collavo is a writer for the Cornell SC Johnson College of Business.
