Forecasts improve with societal links

Analysts who speak CEOs' language, share caste/school ties give more accurate earnings estimates, says ISB-INSEAD study

A study of about 140 large and listed Indian companies over 10 years has shown that analysts’ forecasts of earnings were more accurate if they spoke the same language as the senior management or shared a caste or educational background.

The study examined 1,552 forecasts between 2001 and 2010, examined 141 firms, 191 chief executive officers (CEOs) and 296 analysts.  Professors from the Hyderabad-based Indian School of Business and Singapore’s INSEAD found analysts depend on information available through networks based on social ties with company CEOs to make accurate predictions.

Raveendra Chittoor, assistant professor, strategy, at ISB, said these ties affect the quality of information available to them. “Analysts often rely on embedded social ties to CEOs of target firms to access private material information that enables more accurate forecasts,” he said. He declined to say if this could be construed as evidence of insider trading.

SOCIAL TIES AID ACCURACY OF ANALYST ESTIMATES

• Social ties help analysts gain access to private information
• Post-reform CEOs more affected by school ties
• Pre-reform CEOs respond more to caste or language affiliations
• The relationship is stronger in Indian business groups, less so in multinationals
• Suggests social relationships play an important role even as India is modernising

The study shows the nature of social ties which would facilitate such sharing depends on what company the CEO works for and whether he is from the pre-reform era or after. Post-reform CEOs are more likely to be influenced by school-based ties; pre-reform ones are more affected by caste and language factors, according to the study.

Also, such ties have more of an effect if the company is part of an Indian business group and less if it is a multinational.

“The main effect of the caste, language or school ties between the equity analyst and the CEO on the analysts’ EPS (earnings per share) forecast of the focal firm is likely to be mitigated when the focal firm is an Indian subsidiary of a Western multinational corporation…(and)…amplified when the focal firm is affiliated to an Indian business group,” said the study, titled ‘Modernising without Westernising: Social structure and economic action in the Indian financial sector.’

Issue*d in January 2014, the study was authored by Balagopal Vissa, Raveendra Chittoor and Guoli Chen. It concludes that “businesses in transitional economies like India might ‘modernise’ without necessarily ‘Westernising’. Here ‘modernising’ means applying reason to solve societal problems, while ‘Westernising’ means approaching an ideal where economic relations are separated from social relations.”

Social relationships play an important role in modern Indian financial markets; Western structures believe in keeping social ties separate from the professional.