July 9 (Bloomberg) — They have to get in. Sometimes it's an Ivy League link they covet. Other times it is that slot at a college that people talk about at church. Either way, college and grad-school applicants clearly believe that a lifelong benefit derives from admission to a certain school.
Recently, a team of economists dubbed this ineffable value a "connection premium." Most of us assume that a business school connection brings the highest reward of all, especially for that clannish crowd, equity analysts. But how much in hard dollars is that premium actually worth?
Sometimes nothing, according to a paper recently posted by the National Bureau of Economic Research by the authors of the connection premium concept. Lauren Cohen, Chris Malloy and Andrea Frazzini — all of whom happen to be connected to premium schools, Harvard or the University of Chicago — studied movements on analysts' buy lists, or recommendations. They found that the analysts' academic ties with executives at companies whose stock they recommended matter not at all when it comes to the returns those stocks earn.
But that's something new, and the change apparently came out of a single rule, the 2000 Securities and Exchange Commission's Regulation Fair Disclosure, or Reg FD. Before Reg FD, which bans sharing company information with select people, analysts enjoyed a connection premium, the authors found.
The authors constructed a hypothetical portfolio to compare returns. Total returns resulting from buy recommendations on companies whose leading figures attended the analysts' alma maters were 8.16 percent a year greater than total returns on buy recommendations for companies to which the analysts had no school tie.
'Never Anticipated This'
I phoned the man who led the SEC in implementing Reg FD, former Chairman Arthur Levitt, to ask him about it.
"We never anticipated this, but I am delighted," said Levitt, who is also a board member of Bloomberg LP, the parent of Bloomberg News.
Cohen, Malloy and Frazzini first scanned analysts' and executives' bios to learn their academic past. Then they looked at the rank of the executive at issue — was he or she on the board of directors, or senior management?
Next, the authors built their portfolio model to compare returns before 2000. The model focused on companies the analysts classed as "buys." It went long on companies with which the analyst had a school tie. The same model shorted those companies when there was no such link.
A connection to board members returned more than no connection at all. A link to senior management yielded even more. Boola, Boola!
Timing Was Everything
Sure, bad news happened to companies while they were in the buy portfolio. But that was more than offset by the gift of earlier or better conveyance of good news from the executive to the analyst. Timing made the difference here: A Yale analyst's sudden decision to move a Yale friend's company stock from "buy" to "strong buy" signaled something that his friend's buy signal did not about the future performance of the company.
This mattered, because school connections turned out to be a factor in the lives of a whole lot of analysts. Looking at an average of 600 equity analysts per year, the authors found a total of some 5,000 school ties for analysts to senior officers. Of those, 19 percent were Harvard connections. Ten percent were from the University of Pennsylvania (the Wharton School, but also the college). Seven percent were New York University links.
Six percent had a Stanford link. Three percent were "Longhorn" ties from the University of Texas. Some 3 percent shared the frigid experience of Lake Michigan ice in February at the University of Chicago.
This suggests something that will come as a relief to the parents of the aforementioned applicants. The connection premium was not an Ivy-only phenomenon.
"It was strong and significant in the non-Ivies, too," says Cohen. In an earlier mutual fund study, Cohen, Frazzini, and Malloy looked at whether schools whose students averaged the highest SAT scores were the ones with higher connection premiums. Again the answer was "no."
"Very small schools have fewer alumni obviously, and those people may seek each other out and have a tighter information network," says Cohen. In any case, such returns for analysts flattened to near zero and stayed there after 2000.
Not Brotherly Fealty
This sheds some light on what it was the analysts were actually getting pre-2000. Some once posited that school ties are valuable because they give a general knowledge of a personality — what Frazzini describes as: "If you and I went to school together, you know whether I am an idiot or not." That thesis suggests returns would have stayed strong after the new regulation.
But the returns changed. That tells us that it is not brotherly fealty but the continuous flow of information long after school years — a phone call, a company visit, going out to dinner — that mattered. Pre-2000, "the CEO was clearly quicker to return phone calls or more forthcoming with material information," says Cohen.
U.K. data also point to the significance of Reg FD. From London, no similar change in regulation came. And the connection premium for British schools remains. If friends tell you the new Britain is a clubless one, they lie. In the 14 years before 2006, the average connection premium was 22.4 percent.
This suggests Reg FD has contributed to making markets more of a meritocracy. By skill and industry, a grad from a small technical college in the Southwest may do just as well as one from Wharton when it comes to analyzing equities.
Further reforms may be a good thing for college applicants and their parents to think about. At least instead of indulging in yet another day of application anxiety.
(Amity Shlaes, a senior fellow in economic history at the Council on Foreign Relations and author of "The Forgotten Man: A New History of the Great Depression," is a Bloomberg News columnist. The opinions expressed are her own.)
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