Fool's Gold: Social Proof in the Initiation and Abandonment of Coverage by Wall Street Analysts

TLDR

This paper examines how social influence shapes Wall Street analysts’ decisions to start and stop covering NASDAQ-listed firms. The authors show that social proof generates information cascades, causing analysts to initiate coverage when peers have recently begun covering a firm. Analysts who begin coverage after such a cascade tend to overestimate future profitability and are more likely to abandon the firm, illustrating a fragile cycle of imitation-driven choice followed by disappointment.

Abstract

This paper examines the dynamics of social influence in the choices of securities analysts to initiate and abandon coverage of firms listed on the NASDAQ national market. We show that social proof—using the actions of others to infer the value of a course of action—creates information cascades in which decision makers initiate coverage of a firm when peers have recently begun coverage. Analysts that initiate coverage of a firm in the wake of a cascade are particularly prone to overestimating the firm's future profitability, however, and they are subsequently more likely than other analysts to abandon coverage of the firm. We thus find evidence for a cycle of imitation-driven choice followed by disappointment and abandonment. Our account suggests that institutionalization rooted in imitation is likely to be fragile.