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E-MailThomas Ruchti is Assistant Professor of Accounting at Carnegie Mellon University Tepper School of Business. This post is based on a paper forthcoming in the Review of Finance by Professor Ruchti; David Hirshleifer, the Paul Merage Chair in Business Growth at the University of California at Irvine Paul Merage School of Business; Ben Lourie, Assistant Professor of Accounting at the University of California at Irvine Paul Merage School of Business; and Phong Truong, Assistant Professor of Accounting at the Pennsylvania State University Smeal College of Business.
In a seminal paper, Asch (1946) finds that if a person is described as “intelligent, industrious, impulsive, critical, stubborn, [and] envious,” people form a more positive impression of that person than when the descriptors are provided in the reverse order. Subsequent psychological research confirms that information received first tends to overshadow information received later, and that first impressions have a lasting effect on perceptions and future behavior (Anderson, 1981). This first impression bias causes a decision maker, assessing the outcomes of some process, to place undue weight on early experiences (Anderson, 1965). If the first impression is particularly positive, then assessments about the future tend to be unduly positive; the reverse is the case if the first impression is negative.
In our recent paper, we provide the first investigation of whether this bias exists in a field setting with finance professionals. We test whether an analyst’s first impression of a firm biases the analyst’s later forecasts and related behaviors. It is not immediately obvious whether this would occur, since analysts have pecuniary incentives to make accurate forecasts. On the other hand, forecasting future outcomes is a challenging and inherently subjective endeavor.
For several reasons, analyst forecasting behavior provides an attractive setting for studying the effects of first impression bias in the field. First, both first impressions, in the form of past firm performance, and analysts’ forecasting errors can be directly measured. Second, analysts make forecasts about multiple firms, allowing us to distinguish bias due to first impressions from an analyst’s average bias. Third, we can measure analyst bias relative to the average forecast made by other analysts following the same firm, at the same time. This within-firm measure allows us to identify bias that is not correlated with average market sentiment about particular firms.
We measure the first impression formed by an analyst about a firm by the firm’s abnormal stock return in the year before an equity analyst’s first forecast for that firm. During this period, the analyst develops an understanding of the firm’s operations, management’s relationship with the board, and the position of the firm within its respective industry.
Using a sample of 1,643,089 firm-analyst observations spanning 1984–2017, we find that equity analysts’ first impressions of a firm have a lasting association with their future forecasting behavior for that same firm. In particular, analysts who experience positive first impressions have more optimistic subsequent forecasts relative to the consensus. Analysts who experience negative first impressions are, in contrast, more pessimistic than the consensus. Furthermore, analysts with positive first impressions issue higher price targets (predicted level of the stock price) and are more likely to issue a Buy recommendation. The opposite patterns hold for negative first impressions.
The effects of first impression bias persist over a substantial time horizon after the analyst starts to follow a stock. For earnings per share (EPS) forecasts, the bias exists for 36 months, on average, but negative impressions last longer than positive ones. While the positive impression effect on EPS forecasts lasts for 24 months, the negative impression effect on EPS forecasts lasts at least 72 months.
This asymmetry in persistence may derive from the phenomenon of negativity bias, which influences how people form impressions (Anderson, 1973). In a wide range of contexts, the influence of negative information and negative experiences is stronger than the influence of comparable positive information and experiences. In addition to our evidence that negative impressions last longer, we find that a negative first impression has at least double the economic effect on EPS forecasts, price targets, and recommendations.
We next investigate whether investors understand and discount for analysts’ first impression bias. If analysts overweight information consistent with their current beliefs, then an analyst with a positive first impression should be more likely to interpret news as positive, leading to more positive recommendation revisions (e.g., Sell to Hold, Hold to Buy). We find that the market reacts less positively to positive recommendations, and more negatively to negative recommendations, made by analysts who have a positive first impression of a firm. We find the opposite pattern for recommendations made by analysts who have a negative first impression. However, we find that the market continues to react negatively to the recommendations of positive impression analysts and react positively to the recommendations of negative impression analysts over the 60 trading days after the recommendation. This suggests that while the market appears to be aware of the first impression bias, it does not fully and efficiently adjust for this bias initially. Instead, there is a sluggish gradual adjustment over time.
Research in finance has often found evidence suggesting that investors or other decision makers put heavier weights on recent events than earlier events (Malmendier and Nagel 2016). Our evidence of first impression bias provides a notable contrast with such findings. To explore and delineate these differences more directly, we investigate the comparative weights analysts place on first impressions versus more recent impressions. We find evidence consistent with a U-shape relationship between impressions and time. Analysts appear to place more weight on recent experiences and their earliest experiences and less weight on intermediate experiences. This indicates that early experiences may have effects on behavior that are similar to recent experiences.
In sum, we present evidence that finance professionals in the field are subject to first impression bias. We contribute to a broad literature spanning applied psychology, marketing, and organizational behavior that has demonstrated first impression bias in the lab for several decision making contexts, such as in evaluations of fairness and credibility, choice of wines, and interpreting online reviews. Our results also provide insight regarding the debate about which experiences matter most to participants in financial markets. We find evidence that individuals put greater emphasis on first and recent experiences compared to intermediate ones. Finally, we provide evidence that the stock market partially adjusts—albeit sluggishly—for this behavioral bias in its reactions to analyst recommendations.
The complete paper is available here.
