Tuesday, June 19, 2007

SSRN-Earnings Forecast Performance and Financial Analyst Turnover During Mergers by Joanna Wu, Amy Zang

SSRN-Earnings Forecast Performance and Financial Analyst Turnover During Mergers by Joanna Wu, Amy Zang:

Super short version: Following mergers, turnover is likely to be a non-linear function of job performance. Specifically, following mergers both poor and good performers are more likely to leave.

Longer version:

Wu and Zang examine analyst turnover and
"...document a U-shaped relation between earnings forecast accuracy and analyst turnover surrounding mergers, i.e., top forecast performers also experience high turnover. We study mergers in the financial industry from 1994 to 2004 when significant consolidation within the industry created considerable analyst turnover. We document that even with the myriad of factors impacting analyst turnover during mergers, analyst performance in forecasting accounting earnings is by far the most influential."
A few interesting tidbits from the paper:

1. Consistent with predictions (and previous studies) analysts who perform poorly are replaced more often.

2. However, unlike previous research, the authors also document higher turnover for good analysts (good predictors of future earnings) following mergers

Why? As the authors state:
"A worker’s productivity is a function of various factors, one of which is his/her firm-specific human capital that reflects the skills and knowledge peculiar to the firm (Parsons, 1972), or a particular combination of various skills that the firm especially values (Lazear, 2003). Mergers likely destroy part of the firm-specific human capital for the financial analysts involved, which combined with some of the other merger-related factors such as culture clashes as discussed later, lead to potential reduction in productivity"
In less formal language: the analyst had done well historically as a result of many factors, suddenly had these factors shaken up in the merger. This shakeup makes it more likely for the analyst to leave. (Of course the fact that the analyst has a good track record also means (s)he has more job alternatives which would also lead to higher turnover.)

This alone is interesting. Then consider further implications of of mergers on the overall labor market. For instance:

"[The] findings speak to the literature on how mergers impact the labor force. Existing studies on top executive turnovers following mergers have tied target CEO turnover to poor target performance and support the disciplinary role of corporate takeovers (e.g., Martin and McConnell, 1991). Our evidence suggests that mergers likely also lead to a brain drain in the broader workforce."

Which deserves a WOW!

Cite: Wu, Joanna Shuang and Zang, Amy Y., "Earnings Forecast Performance and Financial Analyst Turnover During Mergers" (March 2007). Simon School Working Paper No. FR07-01 Available at SSRN: http://ssrn.com/abstract=973750

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