The Powerful Influence of Alumni Networks in High Finance

The Power of Alumni Networks

Networking is – without a doubt – an extremely useful skill that all humans develop through the years. It is a skill that can open people up to new experiences, opportunities, and even completely distinct life paths. Apart from the obvious social implications of networks that we form throughout our lives, recent studies conducted by the Harvard Business Review (HBR) have unearthed yet another role that networks played in the world of high finance from 1990 to 2006.

In the article, The Power of Alumni Networks, Lauren H. Cohen and Christopher J. Malloy revealed that Fund Managers often make “more and larger bets on companies where a senior executive went to the same college” as them. In fact, as the chart below suggests, the results were quite clear. Whenever there was a significant overlap between fund managers and senior executives (i.e same school and same degree), researchers found that annual returns for around 7% higher than other nonconnected investments – a figure that could easily represent tens of millions (or more) in the finance world.

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Perhaps the most obvious relation to the material we have covered in class is the idea of strong/weak ties. In lecture, we reviewed the ‘strength’ of weak ties – particularly when looking for a job. On the other hand, the article focused on the benefits of strong ties. In particular, strong ties appeared to be effective in that fund managers could “understand what it means if a person belonged to a certain club or participated in a specific study program… [and thus] assess executives’ potential as leaders and business owners”. Interestingly, despite the ever-more complicated financial system, this is an idea that relates to our day to day social behaviour. For instance, if we need a friend to drive our cars to a party, we naturally have a tendency to trust certain people over others (for an obvious array of reasons). In a similar vein, fund managers will tend to invest more in people that they already know a little about; that is, they are consciously trying to get as big of an advantage in the cutthroat financial community.

Although the article merely touches on the subject, the studies conducted by the HBR also hint at the fact that a fraction of the higher reported returns could be connected to insider trading within the alumni networks.

   “For stock analysts in the United States, the alumni network effect dampens                                                significantly right around 2001, after the SEC’s Regulation FD (Fair                                                              Disclosure) went into effect and mandated ubiquitous rather than selective                                                communication between CEOs and analysts. (There was no such regulation                                              in the UK, and the effect did not dampen there.)”

Naturally, given the high degree of connectivity between nodes of a particularly ‘strong’ group would make it very easy for insider trading to occur. Regardless, if we give analysts the benefit of the doubt, the article manages to illustrate the effectiveness of strong ties (in particular situations) as opposed to the equally beneficial effects of weak ties in other cases.

 

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