Angels and Demons
The halo effect is a simple, pervasive and powerful psychological bias which sees us anchor onto a single positive feature of a person and then indiscriminately apply it to all of their other traits. So if we perceive someone as physically desirable we’re likely to assume that they’re attractive in all other ways as well. Which is highly fortunate for those beautiful but bad tempered, foul mouthed and cerebrally challenged personalities who commonly grace our multi-media world.
Companies will often attempt to use the halo effect by getting celebrity endorsements from completely unrelated but popular celebrities. Still, trading on such a simple psychological trait would be unlikely to fool savvy investors, you’d think. Wrongly, of course.
Fooled By Oneself
The problem is that it isn’t so much people being fooled as them fooling themselves. The bias was originally observed as long ago as 1920 by Edward Thorndike who spotted that army officers tended to see their subordinates in black or white terms – all good or all bad – but it was a classic study by Nisbett & Wilson in 1977 that showed exactly how hard-wired this is.
The study presented two videos of the same lecturer performing either in nice guy or nasty guy mode. When asked about a whole series of his traits unrelated to the staged performance they’d witnessed the subjects unfailingly rated “Mr Nice” as more attractive than “Mr Nasty”. Following up on this the experimenters investigated how much insight the subjects had into their own biases and came up with the answer of, roughly, none whatsoever. Basically the subjects rejected the idea that their overall perception of the lecturer had affected their ratings of individual attributes.
The halo effect’s been replicated many times since – from advertising campaigns to interview success and from jury behaviour to views for and against nuclear radiation. Where the result depends on whether you’re talking about a power station or an X-Ray machine. And people never, ever realise they’re doing it.
Company Halos
We know that companies go to great lengths to secure celebrity endorsements to capitalise on halos. This can be a valuable marketing tool, although if the celebrity’s halo slips because they end up on the front pages, upside down in a ditch alongside a bemused looking donkey, don’t be surprised if the effect goes in reverse.
Halos are most commonly associated with super-successful companies. It’s very easy to be persuaded that a popular company is a good investment. Take Apple and the iPod, for instance – it’s a hugely successful brand and an equally successful product (indeed, the iPod halo may make the Apple brand appear even more attractive) but is it a good investment? The halo effect can’t tell us much about this directly but may, in fact, turn out to be a negative indicator of future stockmarket performance.
Unfortunately there’s precious little research into the halo effect on investment choice, although it seems as good a reason as any for the oft-observed phenomena of stocks over-reacting to good and bad news, regardless of the long-term prognosis. A number of authors have pointed out the underperformance of stocks following their outing in popular investment books but this is hardly a scientific sample. Fortunately there is some indirect evidence that shows that investors do get duped into investing by the apparent attractiveness of a stock and it comes, rather oddly you might think, from studies of company names.
Company Naming
In the early sixties there was a ‘tronics boom associated with the Space Race. Companies rushed to link themselves to the associated bubble in electronics stocks by coming up with ever more mangled versions of “electronics” in their name. Presumably on the grounds that if a monkey or a communist could operate it in space then it must be good.
Of course, we have a much more recent example of a bubble caused by a displacement event. The rise of the internet caused a stockmarket boom in the late twentieth century and, for a short time, anything associated with the on-line world appeared to be inherently good. It’s not surprising, perhaps, that smart operators decided to hitch a parasitic lift on the positive halo being generated.
A rose.com by Any Other Name
Back in 2000 Cooper, Dimitrov and Rau carried out a study called “A rose.com by any other name” in which they looked at naming effects on internet related companies stock prices. At the time they said:
The naming change wave started in June 1998 and accelerated in early 1999, to startling effect. Companies changing their names to something “internet related” saw an average share price increase of 53% around the name change announcement date. Over the six months around the date average share prices went up over 80%. Better still, from a behavioural psychologist’s perspective, this happened regardless of whether the underlying company’s business was anything to do with the internet or not. Simply the name change was enough.
Dotbombs
Of course, during 2000 and 2001 the dotcom boom went to bust and the “dotcom” tag rapidly became a stigma as the halo effect went into reverse. In boardrooms around the world highly incentivised managements scratched their heads and then decided that if changing their name to something internet related had caused their share prices to move up previously then changing them to something non-internet related might now have the same effect. Of course, investors couldn’t possibly be that stupid but our intrepid researchers decided to take a look anyway.
Companies removing their dot.com tagline promptly saw an average 70% increase in share price, even if the company’s underlying business had nothing to do with the internet. Overall, the more dramatic the name change – and the greater the disassociation from the internet – the greater was the share price boost. Canny managements of non-internet companies who’d changed their names once to capitalise on the positive halo managed to boost their share options by nearly the same amount by changing them again.
Mutual Fund Halos
As you’d expect the willingness to capitalise on the halo effect hasn’t been lost on the mutual fund industry. Yet more research – these guys have been busy – shows this. They find that mutual funds regularly change their names to “take advantage of current hot investment styles” and promptly increase their fund inflows by an average of 28 percent. This happens regardless of whether they actually change the fund’s investing style or not. Unsurprisingly, before the name change the funds were almost invariably experiencing above average fund outflows. Mutual fund marketing wins again.
So as usual, whenever you find investors behaving irrationally you’ll find the investment fund industry making money from them. Sadly, slipped halos oft-times turn into a garotte for investors to strangle their returns. Perceptions of company attractiveness aren't a substitute for proper investment analysis - just like with people, it pays to look under the surface before making a committment.
Related Posts: Loss Aversion Affects Tiger Woods, Too, Peverse Incentives Are Daylight Robbery, The Media, Fear And Stockmarket Manias
The halo effect is a simple, pervasive and powerful psychological bias which sees us anchor onto a single positive feature of a person and then indiscriminately apply it to all of their other traits. So if we perceive someone as physically desirable we’re likely to assume that they’re attractive in all other ways as well. Which is highly fortunate for those beautiful but bad tempered, foul mouthed and cerebrally challenged personalities who commonly grace our multi-media world.
Companies will often attempt to use the halo effect by getting celebrity endorsements from completely unrelated but popular celebrities. Still, trading on such a simple psychological trait would be unlikely to fool savvy investors, you’d think. Wrongly, of course.
Fooled By Oneself
The problem is that it isn’t so much people being fooled as them fooling themselves. The bias was originally observed as long ago as 1920 by Edward Thorndike who spotted that army officers tended to see their subordinates in black or white terms – all good or all bad – but it was a classic study by Nisbett & Wilson in 1977 that showed exactly how hard-wired this is.
The study presented two videos of the same lecturer performing either in nice guy or nasty guy mode. When asked about a whole series of his traits unrelated to the staged performance they’d witnessed the subjects unfailingly rated “Mr Nice” as more attractive than “Mr Nasty”. Following up on this the experimenters investigated how much insight the subjects had into their own biases and came up with the answer of, roughly, none whatsoever. Basically the subjects rejected the idea that their overall perception of the lecturer had affected their ratings of individual attributes.
The halo effect’s been replicated many times since – from advertising campaigns to interview success and from jury behaviour to views for and against nuclear radiation. Where the result depends on whether you’re talking about a power station or an X-Ray machine. And people never, ever realise they’re doing it.
Company Halos
We know that companies go to great lengths to secure celebrity endorsements to capitalise on halos. This can be a valuable marketing tool, although if the celebrity’s halo slips because they end up on the front pages, upside down in a ditch alongside a bemused looking donkey, don’t be surprised if the effect goes in reverse.
Halos are most commonly associated with super-successful companies. It’s very easy to be persuaded that a popular company is a good investment. Take Apple and the iPod, for instance – it’s a hugely successful brand and an equally successful product (indeed, the iPod halo may make the Apple brand appear even more attractive) but is it a good investment? The halo effect can’t tell us much about this directly but may, in fact, turn out to be a negative indicator of future stockmarket performance.
Unfortunately there’s precious little research into the halo effect on investment choice, although it seems as good a reason as any for the oft-observed phenomena of stocks over-reacting to good and bad news, regardless of the long-term prognosis. A number of authors have pointed out the underperformance of stocks following their outing in popular investment books but this is hardly a scientific sample. Fortunately there is some indirect evidence that shows that investors do get duped into investing by the apparent attractiveness of a stock and it comes, rather oddly you might think, from studies of company names.
Company Naming
In the early sixties there was a ‘tronics boom associated with the Space Race. Companies rushed to link themselves to the associated bubble in electronics stocks by coming up with ever more mangled versions of “electronics” in their name. Presumably on the grounds that if a monkey or a communist could operate it in space then it must be good.
Of course, we have a much more recent example of a bubble caused by a displacement event. The rise of the internet caused a stockmarket boom in the late twentieth century and, for a short time, anything associated with the on-line world appeared to be inherently good. It’s not surprising, perhaps, that smart operators decided to hitch a parasitic lift on the positive halo being generated.
A rose.com by Any Other Name
Back in 2000 Cooper, Dimitrov and Rau carried out a study called “A rose.com by any other name” in which they looked at naming effects on internet related companies stock prices. At the time they said:
“... we cannot know with any certainty if the increase in firm value for the dotcom companies is rational, perhaps due to investor expectations of large future payoffs to such firms, or if it is simply a speculative bubble that may deflate in the future. However, the fact that we see firms, which derive apparently little or none of their revenue from the Internet experiencing large dotcom effects, suggests some degree of investor irrationality”.That’s called “academic caution”. Anyway, they didn’t have long to wait before getting an answer to their question.
The naming change wave started in June 1998 and accelerated in early 1999, to startling effect. Companies changing their names to something “internet related” saw an average share price increase of 53% around the name change announcement date. Over the six months around the date average share prices went up over 80%. Better still, from a behavioural psychologist’s perspective, this happened regardless of whether the underlying company’s business was anything to do with the internet or not. Simply the name change was enough.
Dotbombs
Of course, during 2000 and 2001 the dotcom boom went to bust and the “dotcom” tag rapidly became a stigma as the halo effect went into reverse. In boardrooms around the world highly incentivised managements scratched their heads and then decided that if changing their name to something internet related had caused their share prices to move up previously then changing them to something non-internet related might now have the same effect. Of course, investors couldn’t possibly be that stupid but our intrepid researchers decided to take a look anyway.
Companies removing their dot.com tagline promptly saw an average 70% increase in share price, even if the company’s underlying business had nothing to do with the internet. Overall, the more dramatic the name change – and the greater the disassociation from the internet – the greater was the share price boost. Canny managements of non-internet companies who’d changed their names once to capitalise on the positive halo managed to boost their share options by nearly the same amount by changing them again.
Mutual Fund Halos
As you’d expect the willingness to capitalise on the halo effect hasn’t been lost on the mutual fund industry. Yet more research – these guys have been busy – shows this. They find that mutual funds regularly change their names to “take advantage of current hot investment styles” and promptly increase their fund inflows by an average of 28 percent. This happens regardless of whether they actually change the fund’s investing style or not. Unsurprisingly, before the name change the funds were almost invariably experiencing above average fund outflows. Mutual fund marketing wins again.
So as usual, whenever you find investors behaving irrationally you’ll find the investment fund industry making money from them. Sadly, slipped halos oft-times turn into a garotte for investors to strangle their returns. Perceptions of company attractiveness aren't a substitute for proper investment analysis - just like with people, it pays to look under the surface before making a committment.
Related Posts: Loss Aversion Affects Tiger Woods, Too, Peverse Incentives Are Daylight Robbery, The Media, Fear And Stockmarket Manias
It is interesting to see that research backs up the aphorism that the stock market is a voting machine in the short term.
ReplyDeleteWhile it is true that dividends are important to help weigh the market in the long term it is hard to find a snappy title to convey that.
what i'm wondering is: is there any research on how long you have to persist with an investment before the combined effects of fads and bubbles and day-traders and short-sellers are overtaken by bona fide boring good business?
ReplyDeletein the long term it may be a weighing machine, but about how long is that?
Good question. I am sure Tim will write a piece on how long bubbles last. I would say 18 months is the minimum time for a popularity effect to last. On the other hand you could argue that the US and UK property bubble has lasted 50 years, with all the side effects that has had on banks, builders and so on.
ReplyDelete