Do analysts matter for governance?
Evidence from natural experiments
Tao Chen, Jarrad Harford and Chen Lin*
July 10, 2013
Abstract:
wifi密码忘了怎么从电脑上查Building on two sources of exogenous shocks to analyst coverage –broker closures and mergers, we explore the causal effects of analyst coverage on mitigating managerial expropriation of outside shareholders. We find that as a firm experiences an exogenous decrea in analyst coverage, shareholders value internal cash holdings less, its CEO receives higher excess compensation, its management is more likely to make value-destroying acquisitions, and managers are more likely to engage in earnings management activities. Importantly, we find that the most of the effects are mainly driven by the firms with smaller initial analyst coverage and less product market competition. We further find that after exogenous broker terminations, a CEO’s total and excessive compensation become innsitive to firm performance in firms with low initial analyst coverage. The findings are co
nsistent with the monitoring hypothesis, specifically that financial analysts play an important governance role in scrutinizing management behavior, and the market is pricing an increa in expected agency problems after the loss in analyst coverage.
JEL classification: G34; G24; G32; M12; M41
Keywords: Financial analyst; Monitoring; Natural experiment; Analyst coverage; Value of cash holding; CEO excess compensation; Acquisition; Earnings management
* Chen and Lin are from the Chine University of Hong Kong. Harford is from the University of Washington. We thank Thorsten Beck, Andrew Ellul, Swaminathan Kalpathy, Kai Li, Michelle Lowry, Anil Makhija, Vanitha Ragunathan, Cong Wang, Yuhai Xuan, Frank Yu, and conference and minar participants at the 2013 Annual Meetings of the Western Finance Association (WFA), the University of Bristol, the Chine University of Hong Kong, City University of London (Cass), Hong Kong Polytechnic University, University of Hong Kong, University of Illinois at Urbana-Champaign, University of Queensland and Wharton, for helpful comments and discussions. Lin gratefully acknowledges the financial support from the Chine University of Hong Kong and the Rearch Grants Council of Hong Kong (Project No. T31/717/12R).
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1.Introduction
Do financial analysts matter for corporate governance? In their minal paper, Jenn and Meckling (1976) emphasize the governance role of analysts in reducing the agency costs associated with the paration of ownership and control. Specifically, they point out that, “we would expect monitoring activities to become specialized to tho institu tions and individuals who posss comparative advantages in the activities. One of the groups who em to play a large role in the activities is compod of the curity analysts employed by institutional investors, brokers and investment advisory rvices…”(p.354). Indeed, analysts can rve as an external governance mechanism through at least two ways. First, t racking firms’ financial statements on a regular basis, analysts interface with management directly by raising questions in earnings announcement conference calls, which can be regarded as direct monitoring.1 Second, analysts provide indirect monitoring by distributing public and private information to millions of individual investors through rearch reports and media outlets such as newspapers and TV programs (Miller, 2006), which helps investors to detect managerial misbehavior2. We refer to the hypothesis that analysts matter for governance through direct and indirect monitoring as the monitoring hypothesis.
Nevertheless, much of the academic rearch in this area centers on the conflicts of interest betwee
发钗n analysts and ll-side or buy-side clients which results in optimistic bias in earnings forecasts (e.g. Das et al., 1998; Gu and Wu, 2003; O’Brien et al., 2005; Ke and Yu, 2006; Mola and Guidolin, 2009; Groysberg et al., 2011).3 There is a striking paucity of papers that have explicitly tested for a corporate governance role of analysts. In fact, Leuz
1For instance, Dyck et al. (2010) find that, compared to analysts, the SEC and auditors only play a minor role in detecting corporate fraud. Analysts have been directly involved in the detection of fraud in firms like Compaq, Gateway, Motorola, PeopleSoft, etc.
2In a survey of 401 CFOs, Graham et al., (2005) report that more than 36% of managers rank analysts as the most important economic agent in tting the stock price of their firm.
3 Firth et al. (2012) provide a recent review of this literature.
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英语脏话(2003) points out that the link between analysts and firm value is not clearly established in the literature and calls for more rearch. Chung and Jo (1996) find a positive correlation between analyst coverage and Tobin’s Q, but there is an under-rearched and crucial issue: what are the ch
annels through which analysts increa corporate value? More recently, Yu (2008) examines the effects of analyst coverage on earnings management, and finds that firms followed by more analysts manage their earnings less, which is consistent with the monitoring hypothesis.4 Yet none of the extant papers has looked at the role of financial analysts in monitoring other major corporate decisions. Therefore, we try to fill this gap by taking a holistic approach to the monitoring role of analyst coverage in mitigating managerial extraction of private benefits from outside shareholders.
The paucity of the rearch might be partially driven by potential endogeneity concerns (i.e. analyst coverage is likely endogenous). For instance, analysts might tend to cover firms with less vere agency problems. If this is the ca, simple OLS regressions of governance outcomes on the number of analysts following the firm would bias towards finding significant results. Unobrvable firm heterogeneity correlated with both analyst coverage and corporate decisions and policies, could also bias the estimation results. To overcome the endogeneity problem, we rely on two natural experiments, brokerage closures and brokerage mergers, which generate exogenous variation in analyst coverage. The two experiments directly affect firms’ analyst coverage, but are exogenous to individual firms’corporate decisions and policies.5 News of brokerage closures and mergers can easily reach investors through press releas and media outlets. A key advantage of this identificatio
n approach is that it not only resolves endogeneity concerns, but also deals with the omitted
4 We differ by looking at more comprehensive aspects of monitoring by providing three ts of evidence from marginal value of cash holdings, CEO pay, and acquisition decisions. Moreover, we utilize natural experiments to overcome endogeneity concerns. We also revisit the effects of analyst coverage on earnings management using our natural experiments framework, both complementing our main results and corroborating Yu’s findings.
5 The tting have been ud in recent literature, such as Derrien and Kecskes (2013) and Irani and Oesch (2013).
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variable problem by allowing multiple shocks to affect different firms at different times. Using the two natural experiments, we successfully identify 46 brokerage closures and mergers between 2000 and 2010, associated with 4,320 firm-year obrvations that experience exogenous analyst coverage decreas. We compare the monitoring outcomes of the firms from one year prior to the brokerage disappearance (t-1) to one year after the brokerage disappearance (t+1) to ensure that we are capturing only the effect due to the exogenous shocks to analyst coverage, after controlling f
如何画猫or a battery of other factors.6 We provide three distinct and robust ts of evidence in support of the hypothesis that analyst coverage plays an important monitoring role in a firm’s overall corporate governance.
Specifically, we look at the effect of an exogenous decrea in analyst coverage on the marginal value of cash holdings, CEO compensation, and acquisition decisions. As liquid asts, cash rerves are the most vulnerable asts to corporate governance problems for a firm, and entrenched mangers can divert cash for private benefit (Frésard and Salva, 2010). CEO compensation is one of the central issues of governance, and CEOs earn greater compensation when governance structures are less effective (Core et al., 1999). Anecdotal evidences show that recently analysts have tried to curb excessive executive compensation in their reports distributed to their clients. For example, longtime bank analyst Mike Mayo points out in his report that, “…I laid out my ca again: declining loan quality, excessive executive compensation, headwinds for the industry after five years of major growth driven by mergers”.7 Mergers and acquisitions are one of the largest investments for a firm, and the availability of the terms and characteristics of takeover transactions enable us to pin down the agency problems more easily (Jenn and Ruback, 1983). In a study of the agency problems at dual-class firms, Masulis et al. (2009) also look at value of marginal cash holdings, compensation, and acquisitions and we follow the similar framework to
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6 We will further discuss this later in Sections 2 and 6.
7Mike Mayo, “Why Wall Street Can't Handle the Truth”, The Wall Street Journal, November 8, 2011.
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study the monitoring role of analysts. Finally, we revisit the result on earnings management to provide direct evidence on the monitoring effect of analysts (Yu, 2008).法制故事
First, we investigate how the exogenous decrea in analyst coverage affects the marginal value of cash holdings. Cash provides managers with the most discretion over how to spend it, which is largely prone to agency problems. Jenn (1986) argues that entrenched managers would rather retain or invest cash than increa dividends paid out to shareholders when firms do not have good investment opportunities. Among many types of asts that firms posss, cash rerves are particularly vulnerable to agency conflicts (Myers and Rajan, 1998), and when insiders have sufficient control rights, cash holdings are largely at risk of being tunneled out of firms for private benefit (Frésard and Salva, 2010). Indeed, Dittmar and Mahrt-Smith (2007) and Pinkowitz et al. (2006) find that cash is less valuable when the agency problem is more vere, and one dollar of cash holdings within the firm may not be worth a dollar to outside shareholders. Following the metho
dology in Faulkender and Wang (2006), we examine the changes in an incremental dollar of cash’s contribution to firm value from before to after the analyst coverage reduction. We find a significant decrea in the marginal value of internal cash after the reduction in analyst coverage due to exogenous shocks from brokerage closures and mergers. Consistent with our monitoring hypothesis, this evidence demonstrates that investors anticipate that with less analyst coverage, corporate managers are more likely to misu the cash rerves.
In further tests, we find that the drop in monitoring from analysts and the conquent decrea in the value of cash are significantly more pronounced for firms with lower analyst coverage (less than or equal to five analysts). Meanwhile, the effect is insignificant for firms with higher analyst coverage, indicating that the significant effect of the exogenous reduction in analyst coverage is largely driven by the subsample with initially
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