Why hierarchy boosts brokerage firm analyst team performance
For brokerage firms operating in China, there are a number of important reasons why hierarchy in teams of analysts matters – both for the firm and in keeping their investors happy
Chinese brokerage houses need to structure their analyst teams in specific ways in order to improve forecasting performance and boost investor satisfaction, according to new research.
It found that hierarchy within teams of analysts plays an important role for multiple reasons. Not only does it improve forecasting performance, but the study showed that clear-cut structure and hierarchical teams delivered forecasts with more accuracy, less optimism bias, less co-movement with the consensus and stronger investor reactions.
The recently published study, Hierarchy and Performance of Analyst Teams, was conducted by UNSW Business School’s Andrew Jackson (Associate Professor and Scientia Fellow in the School of Accounting), Chao Kevin Li (Lecturer in the School of Accounting) and Wen He (Professor of Accounting at Monash Business School).
There are clear benefits to brokerage houses which get the analyst team structure formula right, they contend.
“To the extent that our research demonstrates an improvement in performance for hierarchical analyst teams, if our results are generalisable to cultures without such a strong adherence to hierarchy, then the benefits to businesses are significant,” said A/Prof Jackson. “Being able to demonstrate greater performance is likely to attract greater business to brokerage houses and retain that business.”
The research is based on a sample of more than 23,600 earnings forecasts issued by financial analyst teams in China from 2007 to 2014. Over this time, a steady increase in the percentage of forecasts issued by hierarchical analyst teams was documented. Since 2010, more than 40 per cent of forecasts are made by hierarchical teams, and this percentage increases to more than 50 per cent in large brokerage houses.
“Preliminary analyses show that larger brokers are more likely to host hierarchical analyst teams. We suspect that this pattern might be a manifestation of on-the-job training adopted by those large brokers,” said Li.
Better forecasting for investors
Analyst teams with a structured hierarchy – that is teams with senior and junior analysts – are more likely to issue more accurate and less optimistic forecasts than analyst teams with no clear distinction in experience. Furthermore, a clear hierarchy means that analyst teams are less likely to “follow the herd” of other analysts and their forecasts.
“We found that teams perform better than individuals in forecasting earnings, but also show that team composition matters. Specifically, we find that hierarchical teams, both senior and junior analysts present, provide more accurate and more pessimistic forecasts than do flat ones,” said Li, who added that hierarchical teams’ forecast revisions also trigger stronger market reactions.
“All these findings imply that hierarchical teams facilitate information production in the capital markets,” he affirmed.
Hierarchy is, fundamentally, about power disparity within a group. It’s a system that makes it clear-cut who’s junior and who’s senior – and gives junior staff direction in terms how to work their way up the ranks and where they need to go in order to climb the corporate ladder.
The research also found that hierarchy can contribute positively to team performance in several ways. Hierarchy can create a psychologically rewarding environment and satisfy individuals’ needs for power, achievement and certainty. It can function as an incentive system and motivate individuals to excel in their jobs and achieve group goals. It can also breed and enforce complementary behaviors and thought processes, while reducing conflict and enhance voluntary cooperation.
However, hierarchical teams are more likely to outperform when there is more procedural interdependence between team members, when there is a stronger belief that the hierarchy is legitimate, and when different bases of hierarchy, such as power and status, are aligned.
“Senior managers fostering a working environment which encourages the respect of senior members is important,” said A/Prof. Jackson.
“Our research also implies that junior staff need to be encouraged to speak up and share their knowledge and new technologies as evidenced by the improved performance of senior analysts after working in a hierarchical team.”
Working your way up
Having senior members in a team provides junior team members with visible examples of career progression opportunities, which can be a strong motivator for junior analysts to be promoted into more senior roles.
Hierarchy can also increase role differentiation and provide a clear division of roles and responsibilities: junior analysts, for example, know they might need to be focusing on data analysis and information collection, while senior analysts are focusing on communicating with managers and clients.
In China, hierarchy based on status, age and experience is widely accepted as the norm, and people at the top of the hierarchy enjoy much more power than those at the bottom.
“The construction of hierarchical teams could be used as on-the-job training to facilitate rookies to improve their performance in complex decision-making processes, for example, earnings forecasts,” Li suggested.
“Flat teams, at best, can only perform as well as individuals. There is no advantage of forming such teams. Teaming more experienced staff with juniors enables better performance.”
The nature of analysts’ work suggests that there is a high degree of interdependence between team members, with the final forecasts and recommendations building on each team member’s inputs of data, analysis and judgments. And final outcomes – such as earnings forecasts and stock recommendations – require building on the information, analysis and judgments of each analyst in the team through industry analysis, modeling and conversations with managers.
As a result, it is likely that analyst teams with a hierarchical structure can work more effectively and deliver better performance in their earnings forecasts compared to analyst teams with a flat structure.
Improving team dynamics
There is also a form of mentoring and reverse mentoring that comes into play in hierarchical teams. Senior analysts improve their forecasts for firms they covered after the formation of hierarchical teams, while junior analysts also experience forecast performance after they join a hierarchical team. “These performance improvements are not observed in occasions where flat teams are present,” said Li.
For teams of analysts, a hierarchical structure is likely to be conducive to team performance for several reasons. Most analyst teams are small, having only two or three members. In small teams, hierarchy simply works because political behavior or excessive competition between team members is less likely to occur in close-knit teams. There’s less competition from within the team, but more from external factors such as outsider analysts at other brokerage houses.
Fierce external competition is likely to outweigh internal competition within teams. What’s more, this external competition could motivate team members to work more collaboratively with each other.
Hierarchy can reduce conflicts in analyst teams as the senior analyst usually has the authority to make decisions.
“By demonstrating that hierarchical teams are associated with increased performance for junior analysts, this demonstrates an effective on-the-job training element which is important to further develop new hires,” said A/Prof. Jackson.
“The improvement in the senior analyst also demonstrates the importance of mentoring relationships, and how these are important at passing on experience but also in gaining new insights. In hierarchical teams, there are also positive spiller effects on senior persons’ performance.”