Analyst following, staggered boards, and managerial entrenchment
Highlights
► Staggered boards affect managers’ incentives to release information. ► Firms with staggered boards attract larger analyst following. ► Firms with staggered boards also exhibit less information asymmetry.
Introduction
Financial analysts play an integral role as information intermediaries, monitors of corporate performance, and economic agents whose actions affect investors’ behavior and security valuation. Thus, an analyst’s decision to “follow” or “cover” 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 coverage (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, Baik et al., 2010, Chen et al., 2007, Autore et al., 2009, Jiraporn et al., 2012). The evidence in the literature demonstrates that analyst coverage offers a myriad of benefits, such as a reduction of information asymmetry and an improvement in liquidity.
Staggered or classified boards constitute one of the most controversial governance provisions. Staggered boards can insulate inefficient managers from takeover market forces, thereby promoting managerial entrenchment. Two powerful studies by Bebchuk and Cohen, 2005, Faleye, 2007 find strong evidence indicating that staggered boards allow managerial entrenchment, ultimately resulting in significantly lower firm value.1 Due to their controversial nature, staggered boards have lately been the focus of many researchers and large activist institutional shareholders. There is also robust empirical evidence that staggered boards have far stronger effects on various corporate outcomes than do other corporate governance provisions (Bebchuk and Cohen, 2005, Jiraporn and Liu, 2008, Jiraporn and Liu, 2011, Jiraporn and Chintrakarn, 2009).
Grounded in agency theory, this study explores how analyst coverage may be influenced by the managerial entrenchment associated with the staggered board. The empirical evidence demonstrates that firms with staggered boards attract significantly more analyst following. We also show that firms with staggered boards experience less information asymmetry (more transparency). It appears that managers protected by the staggered board already enjoy job security and have fewer incentives to conceal information. As a result, staggered boards are associated with more transparency. The more transparent information environment facilitates analysts’ information gathering. Consequently, firms with staggered boards attract larger analyst following.
The association between analyst following and staggered boards 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, stock price, and other corporate governance provisions. The magnitude of the effect of staggered boards on analyst coverage ranges from five to seven times the average impact of other corporate governance provisions, suggesting that staggered boards play a far larger role compared to the average role of other governance provisions. Our results are remarkably similar to those in Bebchuk and Cohen (2005), who find that the impact of staggered boards on firm value is multiple times the effect of other governance provisions put together.2
Although endogeneity is unlikely because staggered boards were rarely adopted or rescinded over our sample period, we execute a number of tests that take into account possible endogeneity. First, we relate staggered boards in the earliest year of the sample to analyst following in subsequent years. The evidence remains robust, suggesting that causality is much more likely to run from staggered boards to analyst coverage. Furthermore, we perform a fixed-effects regression analysis to control for unobservable firm characteristics that may influence both analyst coverage and staggered boards simultaneously. The fixed-effects analysis yields consistent results.
In addition, we seek to understand whether analyst coverage helps improve firm value and, if so, whether the improvement in firm performance is jeopardized by staggered boards. As information intermediaries, analysts represent an external governance mechanism that provides additional oversight over management. Consequently, analysts may improve firm value by reducing information asymmetry and mitigating agency conflicts. Our empirical results lend support to this notion. In particular, we find that firms followed by more analysts exhibit higher firm value, as measured by Tobin’s q. Because staggered boards facilitate managerial entrenchment, which likely leads to more agency costs and information asymmetry, we expect staggered boards to reduce the positive impact of analysts on firm value. We find empirical support for this notion as well. The improvement in firm value that can be attributed to analyst coverage is substantially lower for firms with staggered boards. Our results thus complement those of prior studies that document the deleterious effects of staggered boards (Bebchuk and Cohen, 2005, Faleye, 2007, Jiraporn and Liu, 2008). One way in which staggered boards jeopardize firm value is by reducing the favorable effect of analyst coverage.
Our research lies at the intersection of accounting and corporate finance and therefore contributes to the literature in both areas in several meaningful ways. First, our research complements the existing literature by concentrating on analyst coverage, which represents a class of outside governance mechanisms that is neither directly under control of the firm nor entirely environmentally determined. Most prior research focuses on governance attributes that are either explicitly chosen by the firm or determined by country-specific factors. For instance, firms may enhance governance by selecting high-quality auditors (Fan and Wong, 2002), by cross-listing into high-disclosure environments (Doidge et al., 2004), or by issuing debt contracts that allow for high-quality and intensive monitoring (Harvey et al., 2004). Other research examines governance categories that are determined by the firm’s country of domicile (La Porta et al., 1997, Bushman et al., 2004). Analyst following is especially interesting in that it is not directly chosen by the firm nor is it environmentally specific. It is instead determined by factors outside the firm’s control (Lang et al., 2004).
Second, our research complements prior studies that investigate the cross-country comparison of analyst following and corporate governance. It is challenging to examine corporate governance across countries as different countries may have different corporate governance mechanisms as well as disparate legal and regulatory environments. Instead of international comparison, we offer evidence on how analyst coverage is influenced by variation in governance quality across firms but within the US. We elect to study staggered boards because they are one of the most ubiquitous governance provisions with over half of major US corporations having them. Our logic for choosing staggered boards is borne out by the empirical evidence as the impact of staggered boards on analyst following is shown to be multiple times the effects of other governance provisions put together, highlighting the dominant role of staggered boards among governance mechanisms.3
Third, we contribute to the literature in corporate governance by highlighting the role of staggered boards on a critical corporate outcome such as analyst following. Staggered boards have been the focus of many recent studies and are found to be related to firm value (Bebchuk et al., 2009, Bebchuk and Cohen, 2005, Faleye, 2007), to earnings management (Zhao and Chen, 2008, Jiraporn and Liu, 2011), to capital structure choices (Jiraporn and Liu, 2008), to CEO turnover and CEO compensation (Faleye, 2007), to dividend policy (Jiraporn and Chintrakarn, 2009), to R&D spending (Faleye, 2009), and to acquirers’ announcement period returns (Masulis et al., 2007). Our research aptly fits into this recent, yet fast-growing, strand of the literature that investigates the impact of staggered boards on specific outcomes.
Finally, our results contribute to the literature that investigates the effect of corporate governance on the information environment of the firm. For instance, prior studies show that the information environment of the firm can be influenced by board structure and audit committees (Karamanou and Vafeas, 2005), by outside directors and institutional investors (Ajinkya et al., 2005), by insider ownership (Moyer et al., 1989) and by concentration of ownership (Chang et al., 2000).4 We aptly contribute to the literature in this area by demonstrating that classified boards significantly influence the information environment of the firm.
The remainder of this paper is organized as follows. Section 2 offers the background information and a concise literature review. Section 3 discusses the theory and develops the hypotheses. Section 4 explains the sample construction and describes the data. Section 5 shows and discusses the empirical results. Finally, Section 6 presents the concluding remarks.
Section snippets
Staggered boards and managerial entrenchment
In the US, boards of directors can be either unitary or staggered. In firms with a unitary board, all directors stand for election each year. In firms with a staggered or classified board, directors are divided into three classes, with one class of directors standing for election at each annual meeting of shareholders. Boards can be removed in one of the following two ways. First, a replacement can occur due to a stand-alone proxy fight brought about by a rival team that attempts to replace the
Hypothesis development
Motivated by agency theory, we advance two alternative hypotheses that predict the impact of staggered boards on the extent of analyst coverage.
Sample selection
The original sample is compiled from RiskMetrics (formerly IRRC). RiskMetrics reports data on corporate governance provisions for a large number of US public corporations. The sample firms, mainly drawn from the S&P 500 and other large corporations, represent over 90% of total market capitalization on NYSE, AMEX, and NASDAQ. RiskMetrics collects data on 24 corporate governance provisions, one of which is staggered boards.
Univariate analysis
Table 2 also makes comparisons between firms with staggered boards and those with unitary boards. The t-statistics reveal that firms with staggered boards are significantly smaller in terms of total assets, spend less on research and development, have less volatile stock returns, and have weaker shareholder rights (as shown by a higher Governance Index). Analyst coverage does not differ significantly between the two subsamples. This result, however, has to be interpreted with caution because a
Concluding remarks
Staggered boards have recently attracted the attention of both researchers and many large activist shareholders. This study investigates the impact of staggered boards on analyst coverage. Analysts play a crucial role in the capital market as information intermediaries and as monitors of corporate performance. It is thus important to understand what determines the analyst’s decision to follow or cover a particular firm. We document that firms with staggered boards draw significantly larger
Acknowledgments
We thank an anonymous referee for helpful comments. Part of this research was written while the first author served as a Visiting Associate Professor at Thammasat University, Mahidol University, The National Institute of Development Administration (NIDA), and Chiang Mai University in Thailand.
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