International Corporate Governance and Regulation

Stephen P. Ferris, Kose John, Anil K. Makhija, Stephen P. Ferris, Kose John, Anil K. Makhija

• Éditeur: Emerald Publishing Limited
• Année: 2018
• ISBN:
  9781787565371
• Sujet: Betriebswirtschaft
• Sous-sujet: Business allgemein

Advances in Financial Economics volume 20 deals with International Corporate Governance, particularly the role played by boards of directors, internal organization design and governance mechanisms, franchise agreements, the effect of regulation and policy, the market for corporate control, and strategic alliances.

THE INFLUENCE OF CORPORATE GOVERNANCE MECHANISMS ON THE BEHAVIOR OF FINANCIAL ANALYSTS OF US FIRMS: AN EMPIRICAL ANALYSIS

Ahmed Bouteska

ABSTRACT

The aim of this paper is to analyze the impact of corporate governance (focused on some key mechanisms as board size, board independence, managerial ownership, institutional ownership, and chief executive officer duality) on financial analysts’ behavior in US. Results from panel data analysis for 294 US listed firms observed from 2007 to 2014 show that several attributes of the board of directors and audit committee have no effects on the number of analysts who are following the firm and the properties of analysts’ earnings forecasts. Findings also suggest that firms with independent and large boards and blockholders ownership benefit of more analyst following. In addition, it is proven that analysts’ earnings forecasts are optimistic and more accurate for companies where blockholder ownership, either by managers or external entities have larger quoted spreads but of lower quality for the ones which have greater independent board members and institutional investor’s holding.

Keywords: Corporate governance; financial analysts; analyst following; analyst optimism; forecast accuracy; United States

JEL Classifications: G14; G24; G32; G38; M41

INTRODUCTION

During the previous decade, the US financial market has experienced a wave of accounting scandals in major firms such as Enron, HealthSouth, Tyco, and WorldCom. The supervisory authorities, journalists, researchers, and investors are still looking for those responsible for this crisis of confidence in financial markets. After the indelicate manager, the blind or impotent auditor, here is the manipulator financial analyst and his immoral employer (merchant bank or brokerage firm). They must reply to a serious accusation that of misleading investors in error by irresponsible behavior. Financial analysis is involved in a spate of scandals when it has been noticed that some analysts, while being granted extremely substantial remuneration, had published diverging opinions from those which should be and that they had expressed privately. This is the case of analysts who did not warn the market of accounting problems from which suffered Enron or WorldCom. Moreover, some intermediaries have recommended the purchase of Enron securities just before two months of announcement of the bankruptcy of the energy firm.¹ Perceived then as misleading, manipulative and susceptible to undermine confidence of public savings, the financial analysis has motivated disciplinary actions of supervisory authorities of the US market. A record fine of US$1.4 billion has been paid by leading consulting firms and the most reputable investment banks such as Standard & Poor’s, Morningstar, Value Line […] In order to cope with financial scandals, the US legislator has adopted extremely vigorous regulations which were notably translated through the Regulation Fair Disclosure (Reg FD) and the Sarbanes-Oxley Act (SOX).

The literature on financial analysts, finance professionals is a little developed or privilege little realistic hypotheses. Previous studies have mainly focused on two lines of research. The first concerns the analysis of determinants of follow up of financial analysts such as the disclosure policy adopted by the target firm (Lang & Lundholm, 1996), the proportions of its intangible assets (Barth, Kasznik, & McNichols, 2001), as well as institutional investors’ participation in its capital (Bhushan, 1989). A second line of research focus on the detection of determinants of quality outputs of financial analysts, traditionally defined by optimism or pessimism and the accuracy of future earnings forecasts. In this context, the authors have put in evidence the effect of analyst’s experience (Clement, 1999), his remuneration (Agrawal & Chen, 2012), the diversification of evaluated firm (Duru & Reeb, 2002), and the part of institutional investors in its capital (Ljungqvist, Marston, Starks, Wei, & Yan, 2007) on the quality of analysts’ forecasts. However, it seems interesting to examine the effect of governance mechanisms on financial analysts’ behavior. More precisely, it proves necessary to examine the relationship between governance mechanisms and the number of analysts following, their optimism and the accuracy of their predictions. Thus, we try to enrich the literature on financial analysts as important players on the financial market by attempting to provide answers to the following questions:

Is the system of government one of the determinants of the behavior of financial analysts? Does the effectiveness of a governance system allow to improve the quality of reports of financial analysts? and Are the best governed firms a privileged target for financial analysts as well as their potential employers?

This study investigates the effect of governance mechanisms on financial analysts following, their optimism, as well as on the accuracy of their earnings forecasts of future prospects. Besides, very few studies have analyzed the effect of interaction of several mechanisms of corporate governance both at a time in the same study. These mechanisms include the ownership structure (Frankel, Kothari, & Weber, 2006), institutional investors’ ownership (Bushee & Noe, 2000; Healy, Hutton, & Palepu, 1999), the proportion of external directors among board of directors (Eng & Mak, 2003; Forker, 1992), the presence of a duality structure (CEO duality) in the board of directors (Carapeto, Meziane, & Katherina, 2005; Daily & Dalton, 1994), and the various characteristics of audit committee (Klein, 2002). Our study adds something to the literature concerning the impact of governance mechanisms on transparency. In addition, previous writings have been limited to examine the association relationship between the effectiveness of the governance system and the quality of information issued from the firm (Ajinkya, Bhojraj, & Sengupta, 2005; Dechow, Sloan, & Sweeney, 1996 […]). Due to lack of time and knowledge, investors do not generally rely on this type of “raw” information to make the investment decision. They resort more to specialists of information processing that produce complete and understandable works. Therefore, instead of focusing on the disclosure activity, we attempt to elucidate the effect of governance mechanisms on the quality of information truly transmitted to the market.

The remainder of the paper is organized as follows. The section, Literature Review and Hypotheses Development, discusses previous evidence on accounting conservatism and the internal governance mechanisms. The section Research Design discusses the research design, regression models, and measurements of the variables while section Results and Discussion presents the empirical results and discussions. Lastly, Conclusion section concludes the paper and provides future extensions.

LITERATURE REVIEW AND HYPOTHESES DEVELOPMENT

Ownership Structure

The agency theory proposes explanations for observed behaviors since that exists an agency relationship. Informed agents can privilege their own interest at the expense of other uninformed agents (Jensen & Meckling, 1976). Dissemination of financial information by financial analysts is a particularly important and effective way to protect shareholders from managerial latitude and minority shareholders of the risk of expropriation by majority shareholders. But the analysts’ behavior is not for its turn influenced by the various ownerships of the geography of capital?

Ownership Concentration

The link between the existence of the presence of blockholders and corporate governance was the subject of several studies. Blockholders also known as majority shareholders are by definition small groups of investors often constituted of banks, family holding companies, or even other firms as in the case of cross-shareholding; who hold a significant share of ownership rights or voting rights within a given firm. Demsetz (1983), Shleifer and Vishny (1986) as well as Agrawal and Mandelker (1990) suggest that the concentration of capital is an effective instrument of firm governance insofar as dominant shareholders participate in the management of company or directly exert their influence on managers’ decisions especially in general meetings because of the large number of votes they own. Indeed, in the case of ownership dispersion, the manager’s control becomes weak or even impossible because of the “stowaway” problem. According to Grossman and Hart (1982), such a problem stipulates that an investor whose interest is that other investors from his category engage collectively in an operation or strategy such as the control of managers to which the “stowaway” does not participate individually but he benefits fully. Such a situation puts at the disposal of manager a discretionary margin which allows him to profit from it since he can take a series of measures that do not necessarily maximize value for example: maximize the company’s size rather than his profits, accumulate cash flows rather than pay dividends, pay exorbitant salaries, or to protect yourself against other control mechanisms such as board of directors or audit committee. Therefore, majority shareholders further incited on investment activism in order to protect their significant part of the capital can impose on managers to adopt a transparent disclosure policy to facilitate directly or indirectly the access of financial analysts to various information concerning the firm’s activities, reducing thus the cost of analysis which is a determining factor in attracting analysts (Frankel et al., 2006). The transparency thus supported by blockholders also improves the quality of information to be processed by financial analysts in a way to lighten the bias of their recommendations and predictions of future prospects. On the other hand, dominant shareholders are important players in reducing the optimism of analyst forecasts. They are endowed with important financial resources and an extended relational network (especially in cross-shareholding case) compared to minority shareholders who allow them to control the possible relations of interest between manager and investment banks and thus to prepare a favorable climate for the edition of objective analysis reports.

Certainly that shareholding concentration as a tool for reducing agency costs between shareholders and managers has a positive impact on the analyst services offers and leads to more accurate and less optimistic analyst reports. But if there are no mechanisms limiting the discretionary power of dominant shareholders, another type of agency costs may arise. Dominant shareholders particularly family holdings are indeed likely to manage the company in favor of their own interests which may annoy minority shareholders. The compensated structure thus transforms the agency problem between shareholders and managers into an agency problem between dominant shareholders and minority shareholders (Fan & Wong, 2002; Shleifer & Vishny, 1997). As a result, the majority shareholders can reduce in a direct way when they already belong to management team or indirectly in the case of family or business relationship with managers, the firm’s information transparency in the perspective of using certain information for exploitation of private profits to the detriment of minority shareholders. According to Hope (2003), such a disclosure policy will have a negative effect on the quality of analyst reports as the first users of information disclosed by the firm followed. In front of a situation of lack of information, analysts can no longer be limited to information disclosed by the firm. They invest more in data collection necessary for treatment thereby causing the cost of analysis to increase which is an important factor in attracting analysts around a given firm (Frankel et al., 2006). In other words, the ownership concentration in this case leads to a decrease in analyst following because of the high cost of data collection and the increase of error or even the optimism of analysts’ forecasts, due to collusion of interests of managers and majority investors. In summary, the literature affirms that in a context of agency problems between investors and managers, concentration of capital generates the attraction of analysts as well as the reduction of errors and optimism in their forecasts of future prospects. However, a concentrated ownership structure can induce in a context of conflicts of interest between majority investors and minority ones, a decrease in the services offered by analysts and an increase in optimism bias in their reports. Hence, we propose to test the following hypotheses:

H1. The ownership concentration is likely to positively (or negatively) influence number of analysts following (H1.1), negatively (or positively) their optimism (H1.2), and positively (or negatively) their accuracy of earnings forecasts (H1.3).

Institutional Ownership

Institutional investors have privileged access to information because of their activity, their experience on the market and especially their various direct contacts with managers; but given their outsider status, they cannot directly monitor managerial decisions. Besides, previous works such as those of Healy et al. (1999) and Bushee and Noe (2000) suggest that institutional investors prefer to buy shares of firms which support a transparent disclosure policy. Thus, analyst reports as a source of complementary information to data transmitted by the ...

Table des matières

• Cover
• Title Page
• Climate Policies with Burden Sharing: The Economics of Climate Financing
• Board Gender Diversity and Firm Financial Performance: A Quantile Regression Analysis
• Are Dividends an Outcome of or a Substitute for External Corporate Governance? International Evidence Based on Product Market Competition
• International Evidence on Economic Freedom, Governance, and Firm Performance
• Should We Trust Fund Managers? A Close Look at the Canadian Mutual Fund Governance
• The Influence of Corporate Governance Mechanisms on the Behavior of Financial Analysts of US Firms: An Empirical Analysis
• Corporate Governance That Influences an Investment Intention in the ASEAN-Stars Thai Listed Companies: A Marketing Application for Brokerage Firms
• Reconsidering the Mandate of the Audit Committee: Evidence from Corporate Governance in Israel
• About the Editors
• Index