Managerial control divergence and analysts’ information precision

Abstract

AbstractResearch Question/IssueThis study addresses how financial analysts’ information environment varies with the extent to which insiders’ voting rights diverge from their cash flow rights (i.e., control divergence) in the firm.Research Findings/InsightsThis study finds evidence that both analysts’ public and private information precisions are decreasing with insiders’ control divergence for a sample of US dual class share firms. Dual class share firms feature ownership structures that allow us to measure the control divergence between insiders’ voting rights and their cash flow rights. Furthermore, we document that these effects are more pronounced for firms with lower firm‐level uncertainty and for periods prior to the introduction of the SOX Act. Our results are robust to omitted variables, endogenous ownership, and any selection biases associated with dual class equity.Theoretical/Academic ImplicationsAnalysts’ skill and ability to formulate accurate forecasts are influenced by the quality of their information environment. We provide insights on how ownership mechanisms such as control divergence impact this ability by affecting their information environment. By using empirical proxies that precisely measure analysts’ information environment, we are able to better capture the adverse impact of control divergence on the public and private information that analysts convey in their forecasts.Practitioner/Policy ImplicationsPolicy makers are often concerned about issues that can constrain information processing by intermediaries such as analysts. Control divergence mechanisms can negatively impact analysts’ information processing by affecting their information environment and consequently their ability to effectively forecast earnings and stock prices. These have larger implications for social welfare and optimal capital allocation in the economy. Policy makers may therefore need to evolve better regulatory norms to negate some of the pernicious consequences of such ownership structures on information intermediation.