IS DIVERSIFICATION A JOB SAFETY NET FOR SELL‐SIDE ANALYSTS?

• Author: Zhanel B. DeVides,Vadim S. Balashov
• Published date: 01 August 2020
• DOI: http://doi.org/10.1111/jfir.12219
• Date: 01 August 2020

Journal of Financial Research Vol. XLIII, No. 3 Pages 543–573 Fall 2020

DOI: 10.1111/jfir.12219

IS DIVERSIFICATION A JOB SAFETY NET FOR SELL‐SIDE ANALYSTS?

Vadim S. Balashov

Rutgers University

Zhanel B. DeVides

Penn State Abington

Abstract

We study sell‐side analysts’motives to diversify their portfolios across industries.

Despite the negative association between diversification and accuracy, more than

60% of analysts cover multiple industries. We argue that analysts’choice to diversify

is rooted in concerns about future job security. We find that more diversified analysts

are less likely to experience job turnover and leave the profession but are not more

likely to advance their careers. For experienced and all‐star analysts, diversification

does not improve career outcomes. We conclude that industry diversification is a

safety mechanism for inexperienced and unranked analysts who are concerned about

job security.

JEL Classification: G11, G14, G24, M41

I. Introduction

Sell‐side financial analysts are viewed as experts in the industries they follow.

Institutional Investor annual polls consistently rank industry knowledge as the most

valuable attribute analysts possess (Bradshaw 2011, 2012). Industry expertise improves

the accuracy of analyst reports, which is valued highly by both buy‐side investors and

analysts’employers—brokerage houses.

1

However, many studies find that accuracy is

lower for analysts who follow multiple industries, because of the diffusion‐of‐focus

effect.

2

This finding suggests that analysts should be able to improve their forecasting

ability by concentrating on one industry and becoming specialists in the field. Although

Myring and Wrege (2009) document that from 1984 to 2006 individual analysts had

greater industry specialization and achieved greater forecasting accuracy, more than

60% of analysts remain diversified. Several studies attempt to explain this phenomenon

(Kini et al. 2009; Sonney 2009; Salva and Sonney 2011; Muslu, Rebello, and Xu 2014;

The authors acknowledge partial financial support from the David Whitcomb Center for Research in

Financial Services of Rutgers University. All errors are our own.

1

More accurate analysts experience better career outcomes (Mikhail, Walther, and Willis 1999; Hong,

Kubik, and Solomon 2000; Hong and Kubik 2003; Jackson 2005; Hilary and Hsu 2013; Altinkilic, Balashov, and

Hansen 2019), have higher salaries (Groysberg, Healy, and Maber 2011), and are more likely to become all‐stars

(Emery and Li 2009; Balashov 2018).

2

For studies of analysts’forecast accuracy, see Jacob, Lys, and Neale (1999), Clement (1999), Kini et al.

(2009), Sonney (2009), Bradley, Gokkaya, and Liu (2016), and Kim, Li, and Zhang (2017). We corroborate a

negative relation between industry diversification and accuracy in the Appendix.

543

© 2020 The Southern Finance Association and the Southwestern Finance Association

Brown et al. 2015; Hameed et al. 2015). We examine security analysts’motives to

cover multiple industries based on analysts’future career concerns, which is a novel

view of individual analysts acting in their own interests that do not necessarily align

with those of employing brokerage houses and their clientele.

Career concerns drive analysts’behaviors because of the competitive nature of

the sell‐side analyst profession.

3

In our comprehensive sample from 2001 to 2015,

one‐third of all employed analysts, on average, change employers or leave the

profession each year. Given the threat of employment turnover, analysts try to

maximize their chances of survival in the profession. We test the hypothesis that

diversification serves as a job safety net by helping analysts stay in the profession. The

benefits of diversification are twofold. First, we show that matching industry coverage

is the most important factor brokers consider when replacing sell‐side analysts.

Diversified analysts are therefore more valuable to brokerage houses because they are

harder to substitute, making such analysts more likely to keep their jobs than

nondiversified analysts. Second, in the case of job turnover, multiple‐industry coverage

improves the likelihood of matching an analyst’s existing industry experience to the

requirements of a job opening. According to the job safety net hypothesis, analysts

with high concerns for job security diversify their research portfolios to stay with the

current employer and to be more marketable in the job market, that is, to increase the

likelihood of being hired by another brokerage house.

Consistent with the job safety net hypothesis, we find that diversification

improves the chances of analysts’survival in the industry. Diversified analysts are less

likely to experience job turnover and are more likely to stay in the profession. We also

test career outcomes hypotheses for well‐established analysts with much experience in

the profession, and analysts who achieved Institutional Investor’sAll‐America ranking

(henceforth, all‐stars). We argue that job safety concerns diminish for experienced

analysts, and therefore diversification is not as critical a job safety mechanism for them

as it is for younger, less experienced, and unknown analysts. Consistent with

predictions, results suggest that the importance of diversification as a job safety net is

mitigated for seasoned and ranked analysts.

An alternative explanation that is consistent with findings is that diversified

analysts possess other attractive qualities that correlate with diversification, such as the

ability to generate trading commissions for the employing brokerage house, learning

quickly, being able to multitask, and having multiple industry connections/access to

managers. These unobservable analyst characteristics might influence their careers,

causing an omitted variables problem during empirical tests. To disentangle the effect

of diversification on analysts’career outcomes, we examine two types of career

outcomes: (1) job security, such as keeping a job and staying in the profession, and (2)

career advancement, such as moving to a higher ranked brokerage house and becoming

an all‐star. The omitted variable explanation suggests that diversification improves

3

Most analysts do not stay in the profession longer than four years, and on average, analysts do not stay

with the same employer for more than two years (Mikhail, Walther, and Willis 1999; Hong, Kubik, and

Solomon 2000; Hong and Kubik 2003; Altinkilic, Balashov, and Hansen 2019; Balashov 2018), which is

comparable to our descriptive statistics.

544 The Journal of Financial Research