Unpacking the Conditions of Reputational Herding: Implications and Evidence

We examine “reputational herding,” where decision makers follow the herd to maintain or improve their reputation, rather than to make optimal decisions for the firm. We propose this as an additional mechanism for firms’ mimetic behaviors. We model the mechanism and demonstrate that decision makers are less likely to herd when they have a high reputation, as it strengthens their confidence in private signals and buffers them against reputational penalties in the event of a bad outcome. Conversely, herding is more likely when experts have highly correlated information (high “signal correlation”). The model’s prediction on the effect of reputation differs from previous research; the model’s secondary predictions on the effect of signal correlation distinguish reputational herding from informational herding. We test the theory in the context of sell-side stock analysts and employ a difference-in-differences design to compare award-winning analysts and runners-up with similar ability to assess the impact of a reputation shock on herding behavior. The overall results are consistent with the reputational herding mechanism. We discuss several managerial implications of the model and provide recommendations regarding how to mitigate the moral hazard problem of reputational herding.