How Do Powerful CEOs Affect Analyst Coverage?

Date01 June 2014
Published date01 June 2014
European Financial Management, Vol. 20, No. 3, 2014, 652–676
doi: 10.1111/j.1468-036X.2012.00655.x
How Do Powerful CEOs Affect Analyst
Pornsit Jiraporn
Great Valley School of Graduate Professional Studies, PennsylvaniaState University, USA and
Thammasat University, Mahidol University,Chiang Mai University, National Institute of
Development Administration (NIDA), Thailand
Yixi n Liu
University of New Hampshire, Whittemore Schoolof Business and Economics, University of New
Hampshire, USA
Young S. Kim
Haile/US Bank College of Business, Northern Kentucky University,USA
We examine how CEO power affects the extent of analyst coverage.CEO power can
influence a CEO’s incentives to disclose information. The amount of information
disclosed by the CEO in turn influences the information environment, which affects
financial analysts’ incentives to follow the firm. Consistent with this notion, we
show that firms with powerful CEOs are covered by fewer analysts. In addition, the
evidence shows that firms with more powerful CEOs experience less information
asymmetry. Powerful CEOs are well insulated and have fewer incentives to conceal
information, resulting in moretransparency. The information providedto investors
directlyby the f irm substitutes for the informationin the analyst’s report.As a result,
the demand for analyst coverage is lower. Our results are important because they
show that CEO power affects important corporate outcomes such as corporate
transparency and analyst following.
Keywords: analystcoverage,analyst following,CEO power,agency theory,agency
JEL classification: G34, M41
Forvaluable comments and suggestions, we thank the editor, John Doukas, and an anonymous
referee. Part of this research was written while the first author served as a Visiting Associate
Professor at Thammasat University, Mahidol University, Chiang Mai University and The
National Institute of Development Administration (NIDA) in Thailand.
2012 Blackwell Publishing Ltd
© 2012 John Wiley & Sons Ltd
How Do Powerful CEOs Affect Analyst Coverage? 653
1. Introduction
Financial analysts constitute a key group of economic agents in the capital market.
As information intermediaries and monitors of corporate performance, analysts perform
several economic functions that directly influence security valuationas well as investors’
judgment and behaviour. Thus, an analyst’s decision to follow a particular firm is
important and has attracted tremendous attention in the accounting and finance literature.
An extensive body of research has developed on the determinants of analyst following
(e.g., Bhushan, 1989; Moyer et al., 1989; O’Brien and Bhushan, 1990; Lang and
Lundholm, 1996; Barth et al., 2001; Lang et al., 2004; Autore et al., 2009; Baik
et al., 2010). The evidence in the literature demonstrates that analyst coverage offers
a myriad of benefits, such as a reduction of information asymmetry, greater investor
recognition, and greater liquidity.
Motivated byagency theor y, we seek to understand how analyst coverageis influenced
by CEO power. Although publicly traded companies must meet minimum disclosure
requirements set by the Securities and Exchange Commission (SEC). U.S firms are
allowed considerable discretion in the informativeness of the disclosure and the amount
of detail provided.1The amount of power the CEO exercises in the f irm can influence
his or her incentives to disclose information, and hence the transparency of the
firm’s information environment. Because financial analysts function as information
intermediaries, analyst coverage is related to the information environment of the firm.
We thus hypothesize that analyst following is significantly affected by CEO power.
Analyst following is especially interesting because it is neither directly chosen by the
firm nor mandated by laws and regulations, but is instead determined (at least in part)
by factors beyond the firm’s control (Lang et al., 2004).
The empirical evidence reveals an inverseassociation between CEO power and analyst
coverage; that is, firms where the CEO commands more power drawf ewer analysts. We
measure CEO power by using the CEO’s pay slice (CPS). Developed by Bebchuk et al.
(2011), CPS captures the CEO’s centrality among the f irm’s top executives and has been
shown to affect several crucial corporate outcomes. The negative association between
analyst following and CEO power survives even after accounting for a large number of
other determinants of analyst coverage documented in prior literature, such as firm size,
profitability, leverage, R&D spending, advertising intensity, trading volume, volatility
of stock returns, and stock price. We also control for endogeneity in two ways. First,
we relate CEO power in the earliest year in the sample to subsequent analyst coverage.
The negative relation remains, implying that causality is much more likely to run from
CEO power to analyst following than vice versa. Second, we confirm the result using a
two-stage least squares (2SLS) estimation. The 2SLS result is consistent, indicating that
strong CEO powerlikely brings about, and does not merely reflect, less analyst coverage.
Moreover,we show that the results are unlikely affected by the omitted variableproblem.
In particular, we exploit the insight of Altonji et al. (2005) to estimate how strong the
effect of the unobservables would have to be to overcome the effect of the observables.
It does not appear that our results are vulnerable to the selection due to unobservable
1For instance, firms are permitted to use discretion in the number of segments reported,
how they aggregate operations into segments, and whether they include segmental data in
quarterly reports.
2012 Blackwell Publishing Ltd
© 2012 John Wiley & Sons Ltd

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