Buy, Sell or Hold: Can Culture Influence Analyst Recommendations?
CUHK research finds that analysts who come from more individualistic cultures are more likely to issue bold earnings forecasts and stock recommendations, but the market usually discounts these bold reports
By Jaymee Ng, Principal Writer, China Business Knowledge@CUHK
Culture shapes the way people work and play. It is also known to affect how people and organisations make economic decisions, as well as how markets behave. In the financial services sector, there is evidence that greater cultural diversity enhances the overall forecasting performance of sell-side financial analysts, but little is known about how specific cultural traits can influence individual behaviour. It is with this in mind that a group of researchers sought to find out how the level of individualism – a key dimension when quantifying cultures – can affect the forecasting behaviours of financial analysts.
The study National Culture and Analysts’ Forecasting Behaviour was jointly conducted by George Yang and Cao Ying, Professor and Associate Professor, respectively, at the School of Accountancy at The Chinese University of Hong Kong (CUHK) Business School in collaboration with Prof. Rubin Hao at Beijing Normal University. The researchers discovered that analysts who hailed from cultures with more individualistic tendencies tend to overweight information they derived by themselves and deviate from consensus, whereas their more collectivist prefer to conform to the consensus.
“Analysts tend to inherit individualist or collectivist traits from their culture of origin.” – Prof. George Yang
“America is a nation of immigrants, and it gave us the opportunity to see how culture can affect analyst forecasts in this melting pot of a market,” says Prof. Yang. “We found that analysts tend to inherit individualist or collectivist traits from their culture of origin, which affects how they process information and this in turn influences their role as information middleman in the capital market.”
The Bird That Sticks Out
The researchers sampled over 9,000 analysts in the U.S. across 68 different cultural backgrounds. Each analyst was assigned a score that represented their likely level of individualism based on his or her country of origin on Hofstede’s cultural index – a framework developed by Dutch social psychologist Geert Hofstede to understand the differences in culture across countries. In general, this led to analysts with cultural ties to the U.K. and its former colonies – Australia, Canada and the U.S – having the highest individualism scores. This was followed by analysts whose roots hailed from Northern and Western Europe, such as Netherlands, Italy, and France. In comparison, analysts with backgrounds in Asian countries, South America, and Africa typically scored the lowest in terms of their level of individualism. This score was then cross-referenced with the analyst’s forecasts and stock recommendations in the past.
The study results show that a change from the lowest individualism level to an average level increases the odds of the issuance of a bold forecast by a percentage point varying between 3.8 and 9. Also, the odds of issuing a bold stock recommendation increases by a percentage point varying between 5.7 and 7.3 when the degree of individualism level changes from the lowest to the typical level.
“’The bird that sticks out always gets shot’ is a well-known Chinese proverb, and it summarises the idea that people who grew up or were influenced by their background in collectivistic cultures tend to avoid acting in a way that would draw undue attention to themselves. On the other hand, people with background ties to more individualistic cultures are usually encouraged to be different and unique, either as a result of their upbringing or peer influence. It’s also not inconceivable that this national culture can also affect how analysts subconsciously make decisions in their forecasts as well as whether they recommend investors to buy, sell or hold a particular stock,” says Prof. Cao.
Self-Confidence and Private Information
The researchers explain that analysts who hail from individualistic cultures typically exhibit greater self-confidence, and this can lead them to overweight their private information that they gathered as part of their research process. They also tend to possess a stronger belief in their ability to analyse this information.
“Due to this strong self-confidence, individualistic analysts don’t tend to feel an over-riding necessity to conform to the consensus forecasts of their peers,” says Prof. Yang. “They tend to be more interested in forming unique, somewhat bold forecasts and stock recommendations. In short, they are happy to stand apart from the crowd.”
Prof. Yang adds that while individualistic analysts tend to be more confident, this did not mean that they were more accurate than their collectivistic peers. “Although bold reports generate strong market reactions, those issued by individualistic analysts are also more likely to be discounted by the market, presumably because these analysts tend to overemphasise their private information,” he says.
The Individualistic Discount
The study found the market typically reacted in a stronger manner to bold reports issued by collectivist analysts than to those with more individualistic inclinations. The results show that when analyst individualism increases from the lowest level recorded to the average, the market discounts their stock recommendations by 38.5 basis points – which represents 22.6 percent of the average price effect of a bold recommendation. This suggests that the market does not view the private information revealed by individualistic analysts as informative as the information uncovered by collectivist analysts.
On the other hand, the study notes that individualistic analysts play a more significant role than their collectivist peers in reducing stock price synchronicity, which is a measure of the degree to which stock prices reflect market-wide information as opposed to firm-specific information. A higher stock price synchronicity represents a lower informative stock price, meaning that investors may find it more difficult to understand the firm due to less firm-specific information.
The researchers measured the stock price synchronicity of firms that lost coverage by an individualistic or a collectivist analyst as a result of the merger or closure of the brokerage they work for. They found that the stock price synchronicity of firms that lost coverage by individualistic analysts increased. This effect was especially strong when fewer analysts covered the firm. “These analysts may have gone to the same business schools or share similar work experiences, but their inherited culture can propel them into making drastically different forecasts,” Prof. Cao says. “This new cultural perspective can help us to better understand the reason for why analyst forecasts can be so diverse.”
Other Cultural Dimensions
The research team delved deeper into the cultural impact on analysts. They found that analysts from collectivist cultures tend to be bolder if their ancestors immigrated to the U.S. earlier. This suggest that although cultural impacts could last across generations, it deteriorates over time.
“Inherited culture can propel analysts into making drastically different forecasts.” – Prof. Cao Ying
Interestingly, the researchers also discovered other cultural traits that influenced analyst forecasting behaviours. For instance, they found that analysts who come from cultures where people prefer to avoid high uncertainty are less likely to issue long-term forecasts and more likely to follow low-risk companies. The level of uncertainty avoidance is another of the factors (besides the level of individualism) that the late-Prof. Hofstede used to analyse cultural differences between countries as part of his Cultural Dimensions Theory. Examples of countries which score high in terms of uncertainty avoidance include Greece, Belgium, Russia and Italy. Such behaviour is in line with their risk aversion tendency.
On the other hand, analysts from long-term oriented cultures (another of Hofstede’s cultural dimensions) tend to favour issuing long-term forecasts as their culture places equal importance on the future and the present time. Long-term oriented cultures, such as China and Japan, typically foster virtues such as perseverance and thrift.
“Business leaders in the financial services industry are under increasing pressure to diversify the labour force. However, little is known about how racial and ethnic diversity affects the workers. The results of our study can help business leaders and policy makers to better understand how national culture influences the behaviour of financial professionals and their impact on the capital market,” Prof. Yang says.
Yang, George Yong（楊勇）
Director, School of Accountancy
Outstanding Fellow of the Faculty of Business Administration