Security Analysis, Agency Costs, and Company Characteristics
Introduction (Via Financial Analysts Journal)
We appraise the monitoring activity of security analysis from the perspective of the manager–shareholder conflict. Using a data set of more than 7,000 company-year observations for manufacturing companies tracked by security analysts over the 1988–94 period, we found that security analysis acts as a monitor to reduce the agency costs associated with the separation of ownership and control. We also found, however, that security analysts are more effective in reducing managerial non-value-maximizing behavior for single segment than for multisegment companies. In addition, the shareholder gains from the monitoring activity ofsecurity analysis are larger for single-segment than for multisegment companies.
Corporate managers have many personal objectives that are not always consistent with the maximization of shareholder value. And although many papers have examined the effectiveness of various internal and external disciplinary mechanisms in terms of restricting managers’ non-value-maximizing conduct, security analysis as an agency-cost monitoring device has been largely unexplored. This omission is surprising in light of investors’ wide use of analyst earnings forecasts in investment decisions and the great influence forecasts (rather than historical measures of growth) have on stock prices. Several researchers have examined the determinants of security analysis (Bhushan 1989; Moyer, Chatfield, and Sisneros 1989; Brennan and Hughes 1991) and the valuation effects of security analysis (Chung and Jo 1996). But although these studies provided interesting insights into the effects of security analysts, they did not directly examine the effects of security analysis on the conflict between managers and shareholders. In addition, the relative effectivenes of security analysis for companies with different industrial structures has been overlooked. Jensen and Meckling (1976) argued that the monitoring activity of security analysis helps reduce the agency costs associated with the separation of ownership and control by restricting the non-value-maximizing behavior of managers. Thus, agency costs should decline as a result of the monitoring activity of security analysts. We set out to address this issue.