Does Monitoring Effect Explain the Relation between Analyst Following and Firm Value?

Abstract

Researchers argue that analysts’ information acquisition activities increase firm value through reducing agency costs, i.e., the monitoring effect (Jensen and Meckling 1976; Healy and Palepu 2001). However, the existing empirical evidence on analyst monitoring effect is limited and inconclusive. This paper extends the literature by examining 1) whether analyst following is related to higher firm value; and 2) if the relation is positive, whether the positive relation reflects analyst monitoring effect. We document a positive relation between analyst following and asset value and the positive relation is consistent with analyst monitoring effect as reflected in two aspects. First, the positive effect is significant for cash and much weaker for other assets. This is consistent with a stronger monitoring effect for assets that are subject to higher agency costs or information asymmetry. Second, consistent with analyst following constraining asset mismanagement or motivating more efficient asset use, analyst following is related to higher subsequent operating performance and total payout of cash.