Concentrated Control, Analyst Following, and Valuation: Do...

Journal of Accounting ResearchVol. 42 No. 3 June 2004

Printed in U.S.A.

Concentrated Control, AnalystFollowing, and Valuation: DoAnalysts Matter Most When

Investors Are Protected Least?

M A R K H . L A N G , ∗ K A R L V . L I N S , †A N D D A R I U S P. M I L L E R ‡

Received 6 January 2003; accepted 29 December 2003

ABSTRACT

This paper uses a sample of more than 2,500 firms from 27 countries to in-vestigate the relation among ownership structure, analyst following, investorprotection, and valuation. We find that analysts are less likely to follow firmswith potential incentives to withhold or manipulate information, such as whenthe family/management group is the largest control rights blockholder. Fur-thermore, this relation is stronger for firms from low-shareholder-protectioncountries. Using valuation regressions that take into account potential endo-geneity between analyst following and firm value, we find a positive valuation

∗University of North Carolina; †University of Utah; ‡Indiana University. We thank RichardLeftwich (the editor) and an anonymous referee for detailed suggestions on improving thepaper. We also thank Yiorgos Allayannis, Amy Dittmar, William Goetzmann, Rebecca Hahn,Ole-Kristian Hope, Mike Lemmon, Yvonne Lu, Marlene Plumlee, Dan Rogers, and seminarparticipants at McGill University, Massachusetts Institute of Technology, Swedish School ofEconomics, University of Arizona, University of Oregon, University of Southern California,University of Utah, and University of Virginia (Darden) and for helpful comments. IvalinaKalcheva, Laura Knudson, Alan Montgomery, and Ugur Lel provided valuable research assis-tance. We are grateful for analyst forecast information provided by IBES and ownership datafrom Mara Faccio and Larry Lang. We also thank the Global Competency Centre and PriceWater House-Cooper for providing grant assistance for this project. The third author acknowl-edges financial support from a DaimlerChrysler Faculty Fellowship. A previous version of thepaper was entitled “Do Analysts Matter Most When Investors Are Protected Least? InternationalEvidence.”

589

Copyright C©, University of Chicago on behalf of the Institute of Professional Accounting, 2004

590 M. H. LANG, K. V. LINS, AND D. P. MILLER

effect when analysts cover firms that have both potentially poor internal gov-ernance and weak country-level external governance. Overall, our findingssuggest that corporate governance plays an important role in analysts’ will-ingness to follow firms and that increased analyst following is associated withhigher valuations, particularly for firms likely to face governance problems.

1. Introduction

This paper examines the relation among ownership structure, analyst fol-lowing, investor protection, and valuation. Using a sample of 2,507 firmsfrom 27 countries, we provide evidence on the following questions. First, isthe presence of concentrated family/management control related to ana-lysts’ willingness to follow a firm, and if so, is analyst reluctance to followa firm with concentrated control exacerbated where investor protection isweak? Second, is higher analyst following associated with higher firm valu-ation, and if so, does the strength of the relation depend on the extent ofconcentrated control and the general investor protection environment?

We analyze these issues in a non-U.S. context because several studies indi-cate that the underlying governance issues are likely to be more problematicin this setting. La Porta, Lopez-de-Silanes, and Shleifer [1999], Claessens,Djankov, and Lang [2000], Faccio and Lang [2002], Denis and McConnell[2003], and Lins [2003] find that concentrated family and managementownership of firms’ control rights is prevalent internationally and, further-more, that these control rights often exceed cash flow rights in a given firm.Such ownership structures give rise to potentially extreme agency prob-lems. Additionally, across the world, minority investor protection is typicallyweaker than in the United States, enhancing blockholders’ ability to exploittheir controlling interests (La Porta et al. [1998]).

La Porta et al. [2002], Claessens et al. [2002], Lins [2003], and Lemmonand Lins [2003], among others, find evidence consistent with valuationdiscounts when firm- and country-level governance is weak. Given this evi-dence, an important question arises. Do alternate governance mechanismsexist that may lessen the discount in firm value associated with expectedpoor corporate governance? We assess whether equity analyst coverage isone such alternate governance mechanism.

We document two main sets of empirical findings on the relation betweenthe quality of corporate governance, the extent of analyst following, andvaluation. First, we find that analyst coverage is negatively related to theoverall level of family/management control of a firm and to whether thefamily/management group is the largest controlling blockholder of a firm.We postulate that these control measures serve as proxies for the extentof effective managerial control, which is likely to be associated with theexpected agency costs of managerial entrenchment. The negative relationbetween concentrated family/management control and analyst coverage isparticularly strong for firms from weak-investor-protection environments.We find no relation between analyst coverage and control rights held byblockholders other than family/management. These results suggest that

CONCENTRATED CONTROL 591

analysts are less likely to follow firms with potential incentives to withholdor manipulate information.

Second, we use ordinary least squares (OLS) as well as simultaneous equa-tion regression models to show that analyst coverage is positively and signif-icantly related to Tobin’s Q in our full sample of countries. Simultaneousestimation is important in this context because of the possibility that ana-lysts might be attracted to firms that take other value-increasing actions.Furthermore, we provide evidence that the interaction of analyst cover-age and effective family/management group control is positively relatedto value, particularly in countries of non-English legal origin and in coun-tries that have relatively low levels of shareholder rights. Our models indi-cate that in countries with relatively low investor protection, an incrementalfour analysts offset the lower value associated with concentrated insidercontrol. Overall, these findings suggest that the relation between analystfollowing and firm value tends to be important for firms with poor internalcorporate governance from countries with less developed external corporategovernance.

We note certain limitations in our analysis. First, because we use IBESfor our analyst data, our main tests focus on firms that have existing analystcoverage; therefore, we cannot directly address the valuation implications ofthe initiation of analyst coverage. However, we conduct an analysis includingfirms excluded from the IBES database under the assumption that they haveno analyst following, with similar results. We also analyze firms added to theIBES database and find for this limited sample results consistent with ourcross-sectional analysis. Second, the concentration of managerial controlused in our study is only a proxy for the complex agency problems that makeup the internal governance environment of the firm. Finally, although weattempt to control for simultaneity in our analysis, we cannot definitivelyestablish causality.

The rest of the paper is organized as follows. Section 2 provides motivationfor the hypotheses we test. Section 3 describes our data and sample selection.Section 4 describes the empirical analyses used and contains the results ofthese analyses. Section 5 concludes.

2. Hypotheses

Classic agency theory proscribes that when controlling managers have lessthan full cash flow ownership stakes in their firm, there will be an inherentconflict between these managers and their outside investors (Jensen andMeckling [1976]). Corporate governance mechanisms are means by whichmanagers are persuaded to act in the outside investors’ interest. Looselyspeaking, governance mechanisms can be classified into two interrelatedcategories: (1) country-specific external mechanisms, such as shareholderprotection, the rule of law, and the market for corporate control, and(2) firm-specific internal mechanisms, such as ownership structure, man-agerial incentive provisions, and auditor choice. In this paper we consider


the possibility that the added scrutiny associated with analyst following mayalso have a role in corporate governance, one that is external yet firmspecific.1

The link between financial analysts and corporate governance is naturalbecause analysts, as outsiders, play an important role as informational in-termediaries between the firm and the market. In the process of decidingwhich firms to follow and providing earnings forecasts, price targets, andbuy-sell recommendations, analysts gather information from a wide arrayof sources both internal and external to the firm to assess its economic via-bility and investment potential. As a consequence, they provide potentiallyimportant scrutiny over management’s actions.

The potential governance role of analysts is likely to be particularly impor-tant in international environments, where other governance mechanismsare often weak. Specifically, countries with few shareholder rights and aweak rule of law tend to have publicly traded companies in which control ishighly concentrated and control rights often exceed proportional cash flowownership. Claessens et al. [2002], Lins [2003], Dyck and Zingales [2003],and Nenova [2003] suggest that outside investors discount the shares offirms with these potentially severe agency problems. Thus, this is a contextin which additional scrutiny by analysts could be particularly important.

However, the very environments in which additional monitoring wouldbe most valuable are likely to be less attractive to analysts. For example, firmswith governance problems are likely to be less forthcoming in terms of dis-closure, giving analysts less information to work with in assessing investmentpotential. Leuz, Nanda, and Wysocki [2003] argue that insiders can reducethe likelihood of outside intervention in their affairs by reducing the in-formation content of financial statements through earnings management.2

Research by Lang and Lundholm [1996] and Healy, Hutton, and Palepu[1999] suggests that analysts are less likely to be attracted to firms with poordisclosure. Internationally, Bushman, Piotroski, and Smith [2003a] docu-ment a positive correlation between analyst following and disclosure andinvestor protection.

Even if analysts can identify firms with attractive fundamentals, the abil-ity of their clients to benefit from investing is unclear because any upsidepotential is likely to be expropriated by insiders who tend to trade on infor-mation. For example, Bushman, Piotroski, and Smith [2003b] find that an-alysts are less likely to follow firms in environments in which insider tradingrestrictions are not enforced. Thus, although analysts might serve a valuablefunction by providing additional scrutiny of the firm, they are potentially

1 We are not the first to identify the potential governance role of analysts. Recent corporatescandals such as Enron have highlighted the potentially important role of analysts as indepen-dent monitors (Healy and Palepu [2003], Coffee [2002]).

2 Similarly, Fan and Wong [2002a] find that concentrated ownership is linked with lowearnings-return correlation in East Asia, and Hope [2002] finds that ownership concentration,measured at the country level, is negatively related to firms’ disclosure levels.


less likely to do so because their share of the benefit from any resultingincrease in share value is unlikely to outweigh the cost.3

The preceding suggests the predictions we assess in this paper. Our firstprediction is that analysts are less likely to follow firms for which concen-trated ownership creates the potential for agency problems. In particular,we focus on the level of control rights held by a firm’s family/managementgroup and whether the family/management group is the largest block-holder of control rights. To the extent that controlling managers have theability to extract private control benefits and prefer opacity with respect tothe firm’s financial performance, analysts are likely to be less inclined to fol-low the firm. Furthermore, this effect is expected to be more pronouncedwhere country-level investor protection is weak.

We are not the first to identify a potential link between ownership and an-alyst following. Moyer, Chatfield, and Sisneros [1989] examine the relationbetween insider stock ownership (executives and directors) and analyst cov-erage for a sample of S&P 500 firms in the United States, arguing that greaterequity exposure on the part of managers may result in better aligned incen-tives; therefore, outside monitoring is less important. It is unclear whetherthis logic would extend to our setting for several reasons. First, U.S. insiderownership levels tend to be well below those for our sample of interna-tional firms, and McConnell and Servaes [1990] suggest that managerialownership may mitigate agency problems up to a point, but high levels ofcontrol rights may exacerbate agency issues as managers are no longer ac-countable to minority shareholders. This lack of accountability is likely morepronounced in international settings where control relationships are oftenheld by long-standing family units, the alignment between control and cashflow rights may be weaker, and minority investor protection may be lessdeveloped.

Chang, Khanna, and Palepu [2000] examine the relation between ana-lyst following and concentrated ownership at the country level. Althoughthey find evidence of a negative correlation between analyst following andconcentrated ownership, it is not statistically significant at conventional lev-els. However, their analysis is limited to 27 country observations and theirownership is determined based on the proportion of the top 20 companiesin the country in which concentrated ownership exceeds 20%. As a result,we view the extent to which concentrated ownership is related to analystfollowing to be an open empirical question. Furthermore, conducting theanalysis at the company level substantially increases the power of the testsand permits us to compare the strength of the relation across companiesin the same country, which naturally controls for many economic variables.

3 A counterargument is that poor corporate governance might increase the expected returnsto uncovering “true” performance, in which case more analysts would cover the firm. However,to the extent that insiders use their control to expropriate profits, little may be left for share-holders. Even if the enhanced scrutiny increased share price, the benefits would accrue to allshareholders, creating a free-rider problem.


Also, we are able to compare the strength of the relation across subsets ofcountries, which permits us to investigate the effect of the investor protec-tion environment on the relation between ownership concentration andanalyst following.4

Our second prediction is that when analysts do opt to follow a firm, analystfollowing will be associated with higher firm valuations, particularly whenconcentrated ownership suggests that governance is likely to be weak. Asdiscussed earlier, analysts are likely to find firms with more serious gover-nance problems less attractive. In addition, once attracted to a firm, analystscrutiny likely increases transparency going forward, making it more difficultfor managers to engage in asset transfers, excessive perquisite consumption,or outright theft of earnings.5 As a result, we expect analyst following to beassociated with higher valuations generally, but especially when other as-pects of the governance environment are weak. Specifically, we focus onwhether the relation between analyst following and value is stronger whenthere is concentrated family/management control and the overall level ofinvestor protection is poor. Given the possibility that analyst following andvaluation might be endogenous, we estimate the relations simultaneously.In particular, including determinants of analyst following should at leastpartially control for the possibility that analysts are attracted to firms thathave high valuations for other reasons.

Lang, Lins, and Miller [2003] document that higher analyst followingis associated with higher valuations in the context of cross-listing. How-ever, their focus is on the effect of cross-listing on analyst following, andas they note, there are numerous other changes that occur around cross-listing (e.g., broadened investor base, and increased regulatory and investorscrutiny).6 We are not aware of any literature that attempts to link analyst

4 Bushman, Piotroski, and Smith [2003a, b] also consider determinants of analyst followinginternationally. Bushman, Piotroski, and Smith [2003a] conduct a country-level analysis andfind that financial transparency (a factor that includes analyst following as a component) isnegatively correlated with the proportion of common shares owned by the three largest share-holders in the 10 largest nonfinancial privately owned domestic firms in a country (althoughnot significantly) and with a measure based on the share of country-level production suppliedby state-owned enterprises. Bushman, Piotroski, and Smith [2003b] document that analyst fol-lowing increases after initial enforcement of insider trading laws in a country, suggesting thatanalysts are less likely to follow a firm if they view insider trading as more likely.

5 This is not to imply that analysts necessarily set out to increase corporate value by increasedmonitoring (because much of the benefit would accrue to other shareholders). Rather, theeffect is more likely to occur indirectly as a by-product of analysts gathering information foruse in forecasting cash flows and assessing investment prospects.

6 Gebhardt, Lee, and Swaminathan [2001] examine whether U.S. analyst following (alongwith firm size and trading volume) is indicative of lower information risk as reflected in thecost of capital. Although they find a univariate relation between analyst following and the riskpremium, they do not include analyst following in the multivariate regression because theyargue that, for a U.S. firm of a given size, the information environment is sufficiently rich thatthe number of analysts is not a separable effect. However, they explicitly ignore any potentialeffect of governance on cash flows by using analyst forecasts (which should already reflect any


coverage to valuation across differing governance regimes. However, to theextent that analysts can serve a monitoring role, the link seems naturalbecause monitoring is likely to be most important when the risk of expro-priation is high. Although the desire of blockholders to expropriate wealthmay be universal, we expect that the relation between valuation and analystfollowing and ownership concentration will be strongest in environmentswith relatively low levels of investor protection because there are fewer im-pediments to insider exploitation. In cases in which shareholder protec-tion is strong, insiders’ ability to expropriate wealth is likely to be morelimited.

Our research complements the existing literature by focusing on a classof governance mechanisms that is neither directly under the control of thefirm nor entirely environmentally determined. Most prior research focuseson governance mechanisms that are either explicitly chosen by the firmor determined by country-specific factors. For example, firms may enhancegovernance by choosing high-quality auditors (e.g., Fan and Wong [2002b]),cross-listing into high-disclosure environments (e.g., Doidge, Karolyi, andStulz [2003]), or issuing debt contracts that provide for high-quality andintensive monitoring (e.g., Harvey, Lins, and Roper [2003]). Similarly, someaspects of governance are determined by a firm’s country of domicile (LaPorta et al. [1997, 1998], Bushman, Piotroski, and Smith [2003a]). Analystfollowing is interesting in that it is not directly chosen by the firm nor isit country specific, but it is instead determined (at least in part) by factorsoutside the firm’s control.7

Furthermore, our research highlights the interplay among various sourcesof governance. Ideally, different forms of governance would be negativelycorrelated, so that a lower level of one would naturally be mitigated by higherlevels of others. However, prior research such as La Porta et al. [1998] andLa Porta, Lopez-de-Silanes, and Shleifer [1999] suggests that country- andfirm-level governance tends to move together in the sense that countries inwhich control of firms is highly concentrated also tend to have weak investorprotection, exacerbating the governance problem. Our research suggestsa similar relation between concentrated control and analyst following, inwhich firms with more concentrated control are also scrutinized by feweranalysts. This relation is particularly ironic in the sense that analysts are less

effect of governance on profitability) to infer discount rates. Also, we believe the internationalcontext may be sufficiently different in terms of long-standing control relations and relativelyweak minority investor protection that even a large company can have significant informationalissues. Along these lines, for emerging markets, Aggarwal, Klapper, and Wysocki [2003] findthat U.S. mutual funds overweight their holdings of firms with greater analyst following.

7 Analyst following is not entirely outside of the firm’s control because the firm might,for example, increase disclosure to attract analysts. However, the ability to select analysts isprobably more limited than selecting auditors, where the company explicitly contracts withthe auditor. Similarly, analyst following is affected by country of domicile (e.g., through qualityof accounting and disclosure requirements), but we focus on within-country differences aftercontrolling for country effects.


likely to be attracted to the very firms where they could do the most goodfrom a monitoring perspective.8

3. Data

To examine whether analyst activity is related to firm-level corporate gov-ernance, we obtain analyst coverage data from the Historical IBES Inter-national database. We obtain ownership data for Western European firmsfrom Faccio and Lang [2002] and for emerging market firms from Lins[2003]. Both papers report ownership statistics that could proxy for a firm’sinternal corporate governance environment. For instance, the level of con-trol rights held by the following types of blockholders are reported: fam-ily/management, government, widely held corporations, widely held finan-cials, and miscellaneous (which includes ownership by trusts, cooperatives,foundations, employees, etc.). From these data it is possible to identify thelargest blockholder of a firm’s control rights. Data on the separation ofcash flow ownership stakes and control rights ownership stakes that occurvia pyramid ownership structures and superior voting shares are also pre-sented in Faccio and Lang [2002] and Lins [2003]. However, these dataare categorized using different algorithms, which makes it difficult to con-struct a consistent measure for our analysis.9 Given these difficulties, wefocus our firm-level governance analysis on the control rights held by block-holders because these measures can be consistently identified for all samplecountries.10

Our primary focus is on family/management control rights because it isthe management group (and their families) that actually makes the opera-tional and financial decisions of a firm. As a benchmark, we also examine theimportance of control rights held by other blockholders, which range fromgovernments to widely held corporations. As a group, these blockholderstypically have smaller ownership stakes and are not as likely to shield infor-mation flows and to consume perquisites. In fact, they may actually serve asmonitors to protect their interests and, as a consequence, the interests of

8 It is interesting to contrast this result with Fan and Wong [2002b], who find evidence thatfirms with concentrated ownership choose higher quality auditors (and pay them more). Animportant difference in that setting is that managers explicitly choose auditors whereas analystschoose whether to follow the firm. It is possible that some managers of firms with concentratedownership might prefer to have greater analyst following but do not have a ready mechanismwith which to attract analysts.

9 Faccio and Lang [2002] report the separation of ownership and control for the largestblockholder of their sample firms (which may not be the family/management group), andLins [2003] reports this measure for all holdings of the family/management group (whichmay not be the largest blockholder).

10 We focus on control rights because our interest is in whether analysts can mitigate gover-nance problems created by concentrated managerial control. Although we do not have datato separate the effect of managerial cash flow rights from control rights, the analysis in Faccioand Lang [2002] and Lins [2003] suggests that, for our sample, control rights often exceedcash flow rights because of pyramid ownership structures and superior voting shares.


outside shareholders. Along this line of reasoning, Lins [2003] finds that inemerging markets large nonmanagement blockholdings are positively re-lated to firm value. Similarly, although there is general evidence of the inef-ficiency of government enterprises, it is often driven by political rather thaneconomic considerations (e.g., see La Porta, Lopez-de-Silanes, and Shleifer[2001]), and it is not clear that governmental entities would expropriateassets as readily as family owners might.11 Thus, we do not have clear pre-dictions on the relation between analyst following and other (nonaffiliated)blockholdings.

The main results of the paper are for 1996. This year was chosen becauseit best matches our ownership data. Ownership data from Lins [2003] arefrom 1995 to 1996 and those from Faccio and Lang [2002] are from 1996 to1999, with the majority of sample observations occurring in 1996. Therefore,our primary research design is limited to a cross-sectional analysis. We usedata from the 11th month of the fiscal year to calculate the number ofanalysts following a company, as O’Brien and Bhushan [1990] documentthat analyst activity levels off after the 11th month.

Because we are also interested in the relation between analyst followingand valuation, we obtain valuation data from Worldscope. We use Tobin’sQ as a measure of firm value in regressions that feature analyst following,concentration of control, and control variables.12 Tobin’s Q is computed astotal assets less the book value of equity plus the market value of equity inthe numerator and book value of assets in the denominator, winsorized atthe 1st and 99th percentiles to alleviate the influence of outliers by settingoutlying values equal to the 1st and 99th percentiles, respectively.

Our potential sample of nonfinancial firms from countries covered byIBES in 1996 that also have ownership data contains 2,734 observations.Data from Lins [2003] are already matched to the Worldscope database,but those from Faccio and Lang [2002] are not. Inclusion of Worldscopevariables reduces our sample by 470 firms. Because analyst activity is likelyto depend on the standard deviation of returns, the historical correlationbetween returns and earnings (Lang and Lundholm [1996]), and earningsgrowth, we require three years of prior IBES data for some of our regressionmodels, further reducing our sample by 170 firms. Overall, the sample withownership data, Worldscope data, and IBES analyst forecast data for fiscalyears 1993 to 1996 includes 2,094 firms from 27 countries. Our tests thatincorporate non-English legal origin and shareholder rights are conductedon subsamples that range from 1,033 to 1,264 firms.

11 Also, publicly traded companies with substantial government ownership are often in theprivatization process and are therefore likely to be particularly sensitive to claims of opacity,and analysts may be attracted to them because of additional investor interest.

12 Tobin’s Q is widely used as a measure of firm value in the academic literature. Researchareas in which Q is used include cross-listing (Doidge, Karolyi, and Stulz [2003]), corporatediversification (Lang and Stulz [1994]), takeovers (Servaes [1991]), equity ownership (La Portaet al. [2002]), and hedging (Allayannis and Weston [2001]).


Table 1 provides summary statistics for the sample based on a firm’s coun-try of domicile.13 Consistent with Chang, Khanna, and Palepu [2000], wefind wide variation across countries in analyst following. The median firmis followed by six analysts. Table 1 also shows descriptive statistics for thetwo measures of ownership concentration we consider: control percentageand largest blockholder. Control percentage measures the proportion ofshares held by a given blockholder group. We assume that the higher thepercentage of control rights, the greater is the potential for governance is-sues. Largest blockholder is an indicator variable that reflects the identityof the blockholder with the largest control percentage (assuming there isone). Control rights held by the largest blockholder are likely to be partic-ularly important because no other blockholder individually has the votes toovercome its position.

From table 1, the median level of control rights held by the family/management group is 18% of the total outstanding. This number varieswidely across countries. Although other large blockholders control largestakes in a few countries such as Argentina and Brazil, their control per-centage is low in most countries. The third set of columns shows thatfamily/management groups are, by far, most frequently the dominant block-holders in our sample firms.

Table 2, panel A presents descriptive statistics for our sample, dividingbetween non-English and English legal origin as measured by La Porta et al.[1998]. The two panels are well balanced in the sense that there are 1,048and 1,046 observations in the non-English and English legal origin par-titions, respectively. For firms that are located in countries that have legalsystems classified as English legal origin, median analyst following is lower (5vs. 7). The finding that analysts tend to follow firms from environments withlow external corporate governance is consistent with Chang, Khanna, andPalepu [2000]. We also find that the median firm size as measured by totalassets is larger in non-English countries (US$782 million vs. US$388 mil-lion). Family/management control is higher in the non-English countries,with a median of 27% versus 13%, and the family/management group ismore frequently the largest shareholder. Tobin’s Q also tends to be higherfor the English legal origin, consistent with investors valuing those firmsmore highly.

Panels B and C present correlations among the variables, partitionedby legal origin. Although there is a negative correlation between family/management control and analyst following for both subsamples, the relation

13 There is a clustering of observations in the United Kingdom, creating the possibility thatthe results are dominated by one country. Given that the analysis is generally based on fixedcountry effects, unique country parameters should be naturally controlled for. Furthermore,results are consistently weaker for countries with strong anti-director rights or from an Englishlegal origin (including the United Kingdom). Deleting the United Kingdom does not affectany of the conclusions.


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is stronger for firms in weak-shareholder-protection environments, suggest-ing that concentrated control may be of more concern to analysts whenthe investor protection environment is generally weaker. The correlationbetween analyst following and size is also higher for low-shareholder-rightscountries, suggesting more of a tendency to cover only the largest firms.The correlation between Tobin’s Q and analyst following is positive in bothenvironments. Most other correlations are fairly weak.

4. Effect of Ownership Structure on Analyst Coverage

4.1 UNIVARIATE TESTS

As our first step in examining the relation between firm-level corporategovernance mechanisms and analyst following, we separate each governancemechanism into two simple categories that represent the potential for pooror good internal governance. Table 3 reports the median analyst followingfor each of these breakdowns. When the firm’s family/management grouphas control rights that are above the country median level, fewer analystsfollow the firm (5 vs. 7, p-value of difference = .00). Because firms in whichthe family/management group has a high level of control rights are ex-pected to face corporate governance problems, this finding suggests thatthe incentives of analysts to cover these firms may be lower. When the fam-ily/management group is the largest blockholder of control rights, we alsosee that median analyst coverage is lower (5 vs. 7, p-value of difference = .00).

T A B L E 3Univariate Tests of Analyst Coverage

Analyst coverage is the number of IBES analysts that report estimates for fiscal year 1996 foreach firm. Ownership data are partitioned based on whether the total direct and indirectcontrol rights held by a blockholder type are above or below median levels for that country.Family/management refers to ownership stakes held by family groups and the top manage-ment group. Other blockholders refers to ownership stakes held by blockholders other thanfamily/management. Largest blockholder refers to the type of entity that has the largest per-centage of control rights in a firm (misc. refers to trusts, cooperatives, charities, employees,etc.; WH = widely held). Ownership structure data are obtained from Faccio and Lang [2002]and Lins [2003].

Analyst Coverage Based on Internal Governance Mechanisms

Above Below p-value ofMedian Median Difference

Family/management control percentageMedian analyst coverage 5 7 0.00Number of observations 1,010 1,084

Family/management is the largest blockholder Yes NoMedian analyst coverage 5 7 0.00Number of observations 1,261 833

Other blockholders control percentageMedian analyst coverage 6 6 0.80Number of observations 866 1,228


Taken together, these univariate results suggest that analyst coverage tendsto be lower for firms with concentrated family/management group control.

For comparison, table 3 also provides median analyst following based onthe control held by other blockholders. We find that when the control heldby blockholder types other than the family/management group is high, thelevel of analyst coverage is not statistically different (6 vs. 6, p-value of dif-ference = .80), consistent with other blockholders generally not presentingthe same governance issues.

4.2 MULTIVARIATE ANALYSIS

Previous research suggests a range of factors besides ownership that arelikely to affect analyst coverage across firms. We follow the models used inLang and Lundholm [1993, 1996] and Lang, Lins, and Miller [2003] andestimate OLS regression models of the following form:14

Analyst following = β0 + β1Ownership variables + β2XLIST

+ β3Firm size + β4Float + β5Earnings growth

+ β6Return STD + β7Returns earnings correlation

+ β8Earnings surprise

+ Industry and country controls,

where:

Ownership variables = family/management control rightspercentage, other blockholders’ con-trol percentage, an indicator variableequal to 1 if family/management is thelargest blockholder of control rights,or an indicator variable equal to 1 if thegovernment is the largest blockholderof control rights

XLIST = an indicator variable equal to 1 ifthe firm has an American DepositaryReceipt (ADR) traded in the UnitedStates that requires reconciliation toU.S. generally accepted accountingprinciples (GAAP)

Firm size = the log of total assets converted to mil-lions of U.S. dollars

14 Given the potential for nonlinearities in the analyst following relation, an alternative wouldbe to use the log of analyst following. We use the level of following for consistency with the papersthat are closest to ours (e.g., Chang, Khanna, and Palepu [2000], Lang, Lins, and Miller [2003],Moyer, Chatfield, and Sisneros [1989]). In addition, the goodness of fit for both the variablesof interest and controls is consistently higher for the raw number of analysts. However, resultsare consistent for log of analysts, suggesting that functional form is not particularly important.


Float = the number of shares not controlled by5% or greater blockholders multipliedby the fiscal year-end share price (inbillions of U.S. dollars)

Earnings growth = the average growth in earnings overthe preceding three years

Return STD = the standard deviation of monthly re-turns over the previous three years(winsorized at the 95th percentile); incases where monthly returns are notavailable, annual returns are used

Returns-earnings correlation = the correlation between annual re-turns and earnings over the previousthree years

Earnings surprise = the absolute value of the difference be-tween current earnings per share andearnings per share from the prior year,divided by the firm’s stock price

Industry and country controls = indicator variables for the firm’s indus-try and country.

Because we are interested in whether ownership structure affects analystfollowing, we focus on the coefficient of the ownership variables. XLIST isincluded in the regressions because Baker, Nofsinger, and Weaver [2002]and Lang, Lins, and Miller [2003] find that firms with exchange-listed ADRshave greater analyst coverage. Firm size, measured as the log of total assetsconverted to U.S. dollars, is included in all regressions because larger firmsare likely to have more analysts covering them (Bhushan [1989], Brennanand Hughes [1991]).15 Float is included because clients of analysts might notbe interested in firms when there is a relatively low volume of shares that floatfreely (Dahlquist et al. [2003]). Earnings growth is included to capture thepossibility that analysts may be attracted to high-growth firms. To control forindustry effects, we include industry classification dummies that correspondto 1 of 12 industrial classifications as outlined in Campbell [1996]. To controlfor cross-country effects, we first estimate all regression models using countryrandom effects. We use the Hausman test to see whether to reject the nullthat country effects are random. When country random effects are rejected,we estimate our regressions with fixed country effects.

Our models also include control variables for analyst following suggestedby Lang and Lundholm [1996]. These controls are the standard deviationof returns, the historical correlation between returns and earnings, and theearnings surprise. These are likely to affect analyst following because theyinfluence both analysts’ incentives to gather information and the inherent

15 We do not use the market value of equity because we hypothesize that market valuation isa function of a firm’s corporate governance and information environment.


difficulty in forecasting earnings. Lang and Lundholm find that return vari-ability is negatively related to the number of analysts following a U.S. firm,indicating that analysts prefer to follow firms with less performance variabil-ity. Low return-earnings correlation is likely to reduce analysts’ incentivesto follow firms because it reduces the potential returns to forecasting earn-ings. Finally, Lang and Lundholm include the percentage earnings surpriseto control for the fact that forecast characteristics are likely to be affectedby the magnitude of the earnings information to be disclosed. Controllingfor the smoothness of earnings is also important in our international settingbecause Leuz, Nanda, and Wysocki [2003] and Fan and Wong [2002a] sug-gest, respectively, that firms from countries with poor investor protectionand firms with poor internal governance manage earnings to mask theirtrue results.16

4.3 RELATION BETWEEN OWNERSHIP STRUCTURE AND ANALYST COVERAGE

Table 4 reports our estimates of the relation between ownership structureand analyst coverage.17 Model 1 shows that after controlling for other factors,an increase in the control rights held by the family/management group cor-responds to a decrease in analyst coverage. The 25th percentile for family/management control is 0 and the 75th percentile is 45%. The coefficient of−0.0337 indicates that, all else equal, a firm in which family/managementcontrol changes from the 25th to the 75th percentile would have 1.5 feweranalysts covering the firm. Overall, the control variables have the expectedsigns and are generally significant. For example, analyst coverage is positivelyrelated to firm size, float, earnings growth, and the correlation between re-turns and earnings. Similar to Lang, Lins, and Miller [2003], the resultsindicate that firms that are cross-listed in the United States and reconcileto U.S. GAAP have more analyst coverage. Analyst coverage is negativelyrelated to the size of the earnings surprise, suggesting that analysts preferto follow firms with less volatile earnings.

Model 2 shows that the control held by all blockholder types other thanthe family/management group is not significantly related to analyst cov-erage. This lack of significance is consistent with the univariate results and is

16 Because the effects of an earnings surprise may be offsetting (analysts prefer firms withmore predictable earnings, yet predictable earnings may indicate more earnings managementthat can dissuade analyst coverage), we also added to our models a variable for the annualchange in accruals as in Leuz, Nanda, and Wysocki [2003]. We find that our results are robustto this additional control and that the accrual variable is not significant in our models.

17 This analysis assumes a particular direction of causality, with more concentrated man-agement control leading to lower analyst following. The notion that concentrated control isexogenous seems reasonable as a first approximation because concentrated control seemslikely to have developed for historical reasons and remains relatively constant over time ratherthan being determined by analyst following. However, to ensure that our conclusions are ro-bust, we reestimate analyst coverage and control rights concentration simultaneously and findconsistent results. A Durbin-Wu-Hausman test also rejects the presence of simultaneity betweenanalyst coverage and family/management control.


T A B L E 4Multivariate Tests of Analyst Coverage

Regression estimates of analyst coverage on disclosure variables of interest and controls. Analystcoverage is for fiscal year 1996 and is defined as the number of IBES analysts that reportestimates for each firm. Family/management refers to control rights held by family groups andthe top management group. Other blockholders refers to control rights held by blockholdersother than family/management. XLIST is an indicator variable that equals 1 if the firm has anADR traded in the United States that requires reconciliation to U.S. GAAP reporting standards.Firm size is the log of total assets in thousands of U.S. dollars. Float is the percentage of sharesnot controlled by ≥5% blockholders multiplied by the market value of equity in billions of U.S.dollars. Earnings growth is the average growth in annual earnings over the prior three years.Debt-to-assets ratio is the ratio of total liabilities to total assets. Returns-earnings correlationis the correlation between returns and earnings over the previous three years. Return STD isthe percentage standard deviation of monthly returns over the previous three years. Earningssurprise is the absolute value of the difference between current earnings per share and earningsper share from the prior year, divided by the firm’s stock price. Dummy variables for industrygroups based on the classification of Campbell [1996] are included but not reported. Thestandard deviation of return on equity is winsorized at the 95th percentile and earnings growthis winsorized at the 5th and 95th percentiles. All regression models are first estimated usingcountry random effects. If the Hausman test rejects the null that country effects are random,models are estimated with fixed country effects. The p-value of the two-tailed t-test of equalitywith zero is reported in parentheses.

Model 1 Model 2 Model 3 Model 4

Family/management control percentage −0.0337(0.00)

Other blockholder control percentage 0.0037(0.56)

Family/management is the −0.8517largest blockholder (0.00)

Government is the largest blockholder 0.7770(0.27)

XLIST 1.3314 1.4185 1.4372 1.5281(0.11) (0.04) (0.09) (0.07)

Firm size 1.6328 1.6878 1.6518 1.6676(0.00) (0.00) (0.00) (0.00)

Float 0.6708 0.7069 0.6924 0.7056(0.00) (0.00) (0.00) (0.00)

Earnings growth 0.2763 0.2578 0.2555 0.2476(0.03) (0.05) (0.04) (0.05)

Return STD −0.0391 −0.0372 −0.0385 −0.0385(0.00) (0.00) (0.00) (0.00)

Return-earnings correlation 0.2499 0.2637 0.2504 0.2478(0.17) (0.16) (0.17) (0.18)

Earnings surprise −0.0192 −0.0183 −0.0182 −0.0183(0.00) (0.01) (0.00) (0.00)

Industry controls Included Included Included IncludedCountry controls Included Included Included Included

Model specification Fixed Random Fixed FixedN 2,094 2,094 2,094 2,094Overall R2 0.46 0.32 0.45 0.45


not particularly surprising because, as mentioned previously, this categoryincludes a wide range of investor groups and there is less of a reason to ex-pect that these outside blockholders have the ability to consume significantprivate benefits of control.

Model 3 replicates the analysis substituting an indicator variable thatequals 1 when the family/management group holds the most control rightsof a firm. Consistent with the results in model 1, analysts are less inclinedto follow firms that are controlled by the family/management group, witha reduction of 0.8517 analysts on average for firms controlled by family/management (p-value = .00). In model 4, we find no evidence that govern-ment control is related to analyst coverage. Overall, our findings are consis-tent with the notion that the expected poor firm-level corporate governancethat accompanies high levels of family/management control of a firm de-creases the attractiveness of following the firm for investment analysts.

4.4 RELATION AMONG OWNERSHIP STRUCTURE,ANALYST COVERAGE, AND INVESTOR PROTECTION

The preceding analysis is based on a broad cross-section of countries.However, the extent to which concentrated control corresponds to gover-nance issues is likely to depend on the investor protection environment. Inparticular, it is possible that an analyst’s willingness to follow a firm is moreaffected by concentrated control if there are not other strong minority in-vestor protections in place. Even in countries with good investor protection,we might expect to see concentrated control associated with reduced ana-lyst following because firms have significant discretion on issues such asvoluntary disclosure—indeed, even in the United States, analyst following ishigher for firms that disclose more. However, the issue is likely to be morepronounced where investor protection is weak because firms are more easilyable to expropriate from minority investors.

Because there is not a clear criterion for establishing that a firm has poorinvestor protection, we consider two criteria.18 First, we differentiate betweencountries based on legal origin. We classify countries with a non-Englishlegal origin as low protection because La Porta et al. [1998] suggest thatcountries with a traditional English legal origin tend to provide strongerinvestor protections. In addition, we use the categorization scheme for anti-director rights in La Porta et al.—a measure that ranges from 0 to 5, withhigher scores corresponding to better protection. We classify countries withanti-director rights below 4 as low-protection countries and those with scoresequal to or above 4 as high-protection countries.

Table 5 presents the association between family/management controlpercentage and analyst following, splitting by investor protection regime.

18 We are unable to incorporate the factors identified by Bushman, Piotroski, and Smith[2003a, b] to affect analyst following because almost all countries in our sample enforcedinsider trading laws and liberalized their financial markets before our sample period.


Consistent with predictions, the coefficient on family/management controlis more than twice as large in absolute value for countries with non-Englishorigin (−.0407) than for countries with English legal origin (−.0166). In ad-dition, the coefficient on family/management control in the low-protectionsubsample is significantly more negative (p-value = .06). Splitting on anti-director rights, the relation is almost twice as large when anti-director rightsare weak (−.0381) than when they are strong (−.0222). However, the coef-ficient for low anti-director rights is not statistically different from the coef-ficient for high anti-director rights at conventional levels using a two-tailed

T A B L E 5Analyst Coverage, Concentrated Control, and Shareholder Protection

Regression estimates of analyst coverage estimated on subsamples of countries with low andhigh shareholder protection as measured by anti-director rights and legal origin. Anti-directorrights values range from 0 to 5 and are obtained from table 2 of La Porta et al. [1998]. Legalorigin is categorized by whether a country’s legal system derived from English common law(La Porta et al. [1998]). Two low-protection subsamples are used. The first contains countriesthat score below 4 on the anti-director rights measure, and the second contains countries witha non-English legal origin. Control variables are described in table 4. All regression modelsare estimated with fixed country effects because the Hausman test rejects the null that countryeffects are random. The p-value of the two-tailed t-test of equality of the coefficient to zero isreported in parentheses.

Panel A: Family/management control percentageShareholder Protection Subsample

(1) (2) (3) (4)Non-English English Anti-Director Anti-DirectorLegal Origin Legal Origin Rights < 4 Rights ≥ 4

Family/management −0.0407 −0.0166 −0.0381 −0.0222control percentage (0.00) (0.05) (0.00) (0.01)

XLIST 2.6021 0.7075 3.4398 1.1206(0.07) (0.49) (0.08) (0.25)

Firm size 2.2185 1.2049 2.2322 1.1714(0.00) (0.00) (0.00) (0.00)

Float 0.6598 0.6479 0.6545 0.6454(0.00) (0.01) (0.00) (0.00)

Earnings growth 0.1584 0.3109 0.1214 0.3299(0.37) (0.07) (0.47) (0.09)

Return STD −0.0406 −0.0444 −0.0209 −0.0768(0.00) (0.00) (0.10) (0.00)


Earnings surprise −0.0165 −0.1080 −0.0170 −0.1052(0.00) (0.00) (0.00) (0.00)


Model specification Fixed Fixed Fixed FixedN 1,048 1,046 1,061 1,033Overall R2 0.48 0.43 0.48 0.47


T A B L E 5 — Continued

Panel B: Family/management is the largest blockholder dummyShareholder Protection Subsample


Family/management is the −1.2182 0.0638 −0.7219 −0.1320largest blockholder (0.01) (0.86) (0.10) (0.74)

XLIST 2.1875 −0.1661 3.4268 −0.1470(0.10) (0.85) (0.04) (0.87)

Firm size 2.4041 1.0905 2.3217 1.1291(0.00) (0.00) (0.00) (0.00)

Float 0.7061 0.6851 0.7111 0.6822(0.00) (0.00) (0.00) (0.00)

Earnings growth 0.2762 0.4206 0.2039 0.4520(0.15) (0.04) (0.26) (0.04)

Return STD −0.0271 −0.0051 −0.0127 −0.0149(0.06) (0.76) (0.36) (0.40)


Earnings surprise −0.0131 −0.1122 −.0127 −0.132067(0.13) (0.08) (0.11) (0.07)


Model specification Random Random Random RandomN 1,048 1,046 1,061 1,033Overall R2 0.37 0.32 0.40 0.31

test (p-value = .13).19 Results for models featuring the family/managementgroup as the largest blockholder, reported in panel B, are similar. Comparingacross legal regimes, the coefficient on effective family/management con-trol is again significantly more negative (p-value = .03) in the non-Englishlegal origin subsample. The coefficient is substantially larger in absolutevalue when anti-director rights are low, but it is not significantly different(p-value = .30).

Overall, we view the evidence in this section as consistent with the notionthat concentrated family/management control creates governance prob-lems that limit analysts’ willingness to follow firms. Furthermore, althoughnot always significant, the effect of concentrated control on analyst cover-age appears to be worse in cases in which there is weak investor protection,suggesting that the agency issues created by weak internal governance areexacerbated when external investor protection is limited. However, the factthat analysts are less inclined to follow firms with potential governance issues

19 The significance level is based on (untabulated) combined regressions in which all variablesare interacted with an indicator variable for a non-English legal system or anti-director rightsbelow 4.


does not imply that analysts would serve a less valuable function for thosefirms. Rather, it is exactly those firms for which analyst scrutiny might be ofthe highest value.

4.5 RELATION AMONG OWNERSHIP STRUCTURE,ANALYST COVERAGE, AND FIRM VALUE

Tobin’s Q is our proxy for firm value. We have 2,507 firms across 27 coun-tries with ownership structure data and 1996 IBES analyst activity data forwhich fiscal year 1996 Tobin’s Q can be computed. We estimate modelsin which Tobin’s Q is regressed on ownership structure variables, analystvariables, and an interaction between these variables, as well as controls.Firm-level controls include XLIST, firm size, debt (measured as total lia-bilities) to assets, capital expenditures to assets, and dummy variables forindustry groups based on the classification of Campbell [1996]. XLIST isincluded to control for the possibility that valuations are higher for cross-listed firms. Doidge, Karolyi, and Stulz [2003] document higher values ofQ for cross-listed firms, consistent with fewer governance problems. Firmsize controls for the possibility that smaller firms have relatively highervalues. The ratio of capital expenditures to assets is a proxy for a firm’spotential investment opportunities, which should be positively related tofirm value. We control for debt to account for the possibility that creditorsare able to lessen managerial agency problems (McConnell and Servaes[1995], Harvey, Lins, and Roper [2003]) or that debt provides valuabletax shields. Later in our analysis, we investigate whether investor protec-tion and legal origin affect our firm-level governance and analyst coverageresults.

Analyst coverage is shown to be positively related to Tobin’s Q in an in-ternational setting (Lang, Lins, and Miller [2003]), and concentrated con-trol in the hands of managers is shown to be negatively related to Tobin’sQ in emerging markets, particularly in markets with the lowest externalshareholder protection (Lins [2003]). We focus on the interaction betweenownership structure and analyst coverage. To the extent that analysts addincremental value to firms with potentially poor internal corporate gover-nance, we expect this interaction coefficient to be positive.

As a benchmark, we first estimate our Tobin’s Q model with our fam-ily/management control variables but without the stand-alone and inter-acted analyst coverage variables. The intent here is to establish whetherconcentrated control is negatively related to Q across countries with a broadrange of external shareholder protection. Our results (untabulated) indi-cate that, across the full sample, concentrated control is not significantly re-lated to Tobin’s Q . When we limit the sample to countries with relatively weakshareholder protection, the relation between family/management controland Tobin’s Q is significant and negative as in Lins [2003]. These find-ings are consistent with the hypothesis that investors discount firms withconcentrated control primarily when the external shareholder protectionenvironment is relatively weak.


T A B L E 6Regressions of Tobin’s Q on Analyst Coverage and Concentrated Control

Regression estimates of Tobin’s Q on analyst coverage and family/management control. Tobin’sQ is computed using data predominantly from fiscal year 1996 and is defined as total assetsless the book value of equity plus the market value of equity in the numerator and bookvalue of assets in the denominator. Tobin’s Q is winsorized at the 1st and 99th percentiles.Family/management refers to control rights held by family groups and the top managementgroup. An interaction variable of analyst activity multiplied by the ownership variable of interestis included. Analyst coverage is for fiscal year 1996 and is defined as the number of IBES analyststhat report estimates for each firm. XLIST is an indicator variable that equals 1 if the firmhas an ADR traded in the United States that requires reconciliation to U.S. GAAP reportingstandards. Firm size is the log of total assets in thousands of U.S. dollars. Debt-to-assets ratiorefers to the ratio of total liabilities to total assets. Dummy variables for industry groups basedon the classification of Campbell [1996] are included but not reported. All regression modelsare first estimated using country random effects. If the Hausman test rejects the null thatcountry effects are random, models are estimated with fixed country effects. The p-value of thetwo-tailed t-test of equality of the coefficient to zero is reported in parentheses.

(1) (2)

Analyst coverage 0.0191 0.0168(0.00) (0.00)

Family/management control percentage 0.0007(0.42)

Analyst coverage ∗ Family/management control percentage 0.0001(0.28)

Family/management is the largest blockholder −0.0153(0.73)

Analyst coverage ∗ Family/management is the largest blockholder 0.0066(0.08)

XLIST 0.2578 0.2592(0.02) (0.01)

Firm size −0.0896 −0.0886(0.00) (0.00)

Debt/assets 0.2491 0.2377(0.01) (0.00)

Capital expenditures/assets 0.8710 0.8725(0.00) (0.00)

Industry controls Included IncludedCountry controls Included Included

Model specification Fixed RandomN 2,507 2,507Overall or adjusted R2 0.25 0.10

Table 6 reports the results of our Tobin’s Q regression models featur-ing family/management control and analyst coverage. The interaction be-tween analyst coverage and the percentage of family/management con-trol in model 1, though positive, is not significant at conventional levels(p-value = .28). In model 2, we find a positive and significant coefficienton the interaction between the number of analysts and the dummy vari-able equal to 1 when the family/management group is the largest block-holder. The coefficient of 0.0066 indicates that when a family/management-controlled firm is followed by an additional analyst, Tobin’s Q values are


0.0234 higher (computed as 0.0168 (unconditional) + 0.0066 (condi-tional)). The control variables are generally in the predicted direction, withTobin’s Q increasing in analyst following, cross-listing, debt-to-assets ratio,and capital-expenditures-to-assets ratio, and decreasing in firm size.

Overall, the table 6 results provide some evidence that analysts are asso-ciated with higher value in firms with potentially poor internal corporategovernance. However, the relation is fairly weak. In part, this may reflectthe fact that concentrated control is not, on average, negatively related tovalue in the full sample of countries. It is possible that analyst monitoring ismost valuable when concentrated ownership is coupled with weak investorprotection. We turn to this issue next.

4.6 SHAREHOLDER PROTECTION AND OWNERSHIP STRUCTURE,ANALYST COVERAGE, AND FIRM VALUE

When outside shareholder protection is high, it is plausible to expect thatthere will be a weaker relation between high levels of family/managementcontrol and value and, similarly, that there will be relatively little roomfor incremental analysts to affect value through their role as monitors.When investors are least protected by the law, managers should be ableto expropriate from outside shareholders more easily. As a result, thereshould be an incremental benefit to the monitoring and disclosure im-provements induced by analyst coverage in this setting, and the relationamong analyst following, firm-level governance, and valuation should bestrongest. In this section, we conduct an analysis of whether our valua-tion results are related to the external shareholder protection of a coun-try. The Hausman test rejects the null specification that country effectsare random in models featuring an interaction between our variablesof interest and the shareholder protection proxies. Therefore, we esti-mate our previous country fixed-effects models from table 6 on subsetsof firms from countries identified as having relatively low shareholderprotection.

Table 7 reports tests for family/management control for the two low-protection subsamples and the corresponding high-protection subsamples.The models show that in the low-protection subsamples, the coefficientson the analyst interaction variables are larger and more significant thanthey were in table 6. Panel A contains regressions using the percentage offamily/management control as our proxy for poor internal (firm-level) cor-porate governance. In both low-protection subsamples, the coefficient onthe interaction between analysts and the percentage of family/managementcontrol is at least double the size of the coefficient obtained when the modelis estimated on the full sample in table 6. Table 7 also reports the coefficientestimates of our models when they are estimated on the high-protection sub-samples. The difference between this interaction variable in the subsamplesof countries with non-English and English legal origin, and anti-directorrights below 4 and equal to or greater than 4 is significant at the 1% and10% levels, respectively.


In panel B, we use the indicator variable equal to 1 when the family/management group is the largest blockholder as our internal governanceproxy. In this panel, we again find that the analyst interaction variables havelarger coefficients than they did in the full-sample model reported in table 6.The interaction variable is different between the subsamples of non-Englishand English legal origin, and anti-director rights below 4 and equal to orgreater than 4 subsamples at the 1% and 5% levels, respectively.

As an example of economic significance, panel B shows that whena family/management-controlled firm from a country with anti-director

T A B L E 7Tobin’s Q Regressions Based on Shareholder Protection

Regression estimates of Tobin’s Q on analyst coverage and ownership structure and estimatedon subsamples of countries with low and high shareholder protection as measured by anti-director rights and legal origin. Anti-director rights values range from 0 to 5 and are obtainedfrom table 2 of La Porta et al. [1998]. Legal origin is categorized by whether a country’slegal system derived from English common law (La Porta et al. [1998]). Two low-protectionsubsamples are used. The first contains countries that score below 4 on the anti-director rightsmeasure, and the second contains countries with a non-English legal origin. Tobin’s Q iscomputed using data predominantly from fiscal year 1996 and is defined as total assets less thebook value of equity plus the market value of equity in the numerator and book value of assetsin the denominator. Tobin’s Q is winsorized at the 1st and 99th percentiles. Control variablesare described in table 4. All regression models are estimated with fixed country effects becausethe Hausman test rejects the null that country effects are random. The p-value of the two-tailedt-test of equality of the coefficient to zero is reported in parentheses.

Panel A: Family/management control percentageShareholder Protection Subsample


Analyst coverage 0.0093 0.0301 0.01381 0.0239(0.04) (0.00) (0.00) (0.00)

Family/management −0.0015 0.0027 −0.0006 0.0022control percentage (0.12) (0.09) (0.49) (0.16)

Analyst coverage ∗ Family/ 0.0003 −0.0002 0.0002 −0.0001management control % (0.01) (0.24) (0.05) (0.67)

XLIST 0.1835 0.2393 0.2445 0.2193(0.19) (0.09) (0.26) (0.07)

Firm size −0.0633 −0.0982 −0.0704 −0.0956(0.00) (0.00) (0.00) (0.00)

Debt/assets −0.4209 0.5820 −0.0414 0.4751(0.00) (0.00) (0.73) (0.00)

Capital expenditures/assets 0.5655 1.1204 0.7384 1.0659(0.04) (0.01) (0.00) (0.01)

Industry controls Included Included Included IncludedCountry controls Included Included Included IncludedModel specification Fixed Fixed Fixed Fixed

Number of observations 1,264 1,243 1,252 1,255Number of countries 20 7 17 10Adjusted R2 0.28 0.26 0.28 0.23



Panel B: Family/management is the largest blockholder dummyShareholder Protection Subsample


Analyst coverage 0.0058 0.0293 0.0102 0.0234(0.23) (0.00) (0.05) (0.00)

Family/management is the −0.1767 0.0943 −0.1068 0.0664largest blockholder (0.00) (0.16) (0.07) (0.37)

Analyst coverage ∗ Family/ 0.0170 −0.0069 0.0148 −0.0027management is largest (0.00) (0.35) (0.01) (0.68)blockholder

XLIST 0.1901 0.2415 0.2673 0.2142(0.17) (0.09) (0.22) (0.08)

Firm size −0.0682 −0.0982 −0.0728 −0.0959(0.00) (0.00) (0.00) (0.00)

Debt/assets −0.4313 0.5779 −0.0406 0.4730(0.00) (0.00) (0.73) (0.00)

Capital expenditures/assets 0.5334 1.1149 0.7097 1.0624(0.05) (0.00) (0.01) (0.01)


Model specification Fixed Fixed Fixed FixedNumber of observations 1,264 1,243 1,252 1,255Number of countries 20 7 17 10Adjusted R2 0.29 0.26 0.28 0.23

rights below 4 is followed by an additional analyst, the interaction co-efficient of 0.0148 is added to the unconditional analyst coefficient of0.0102 so that Tobin’s Q values are 0.025 higher overall. In this case, themodel implies that 4.3 additional analysts would negate the loss in Q of0.1068 indicated by the family/management control variable (computed as0.1068/0.025).

Taken together, the results from tables 6 and 7 are consistent with thehypothesis that, as it relates to the value assigned to firms by outside share-holders, analysts are associated with a smaller discount being placed onfirms with poor internal (firm-level) corporate governance and poor exter-nal (country-level) corporate governance.20

20 Although we do not report results for the concentration of control held by outside block-holders because these measures were not significantly related to analyst following, it is plausi-ble that the impact of analyst coverage on value could vary with the control held by otherblockholders, even though these holdings do not affect the level of analyst coverage. Inunreported tests, we do not find evidence of this in that the interactions of analyst follow-ing with the variables for other blockholder control percentage and for government is thelargest blockholder are not significantly related to value, even in low-shareholder-protectionregimes.


4.7 ENDOGENEITY ISSUES

The preceding tests provide evidence of a relation among ownership con-centration, analyst following, and firm valuation. A concern here is that therelations are endogenous, potentially biasing the results. In particular, ourdesign implicitly assumes causality running from ownership structure to an-alyst following and from analyst following to valuation. However, it is alsopossible that analysts are attracted to firms with high levels of Tobin’s Q forother reasons. Consistent with that, results from a Durbin-Wu-Hausman testindicate potential simultaneity between analyst coverage and Tobin’s Q .

To assess whether simultaneity affects the interaction between family/management control and analyst coverage, we reestimate the precedingmodels simultaneously in a three-stage least squares regression, allowinganalyst following to be a function of Tobin’s Q and vice versa. Specifically,for both of our family/management control measures, the equation fromtable 7 is the structural model and the equation from table 4 is the first-stage equation. Results, reported in table 8, consistently support the con-clusions from tables 4 and 7.21 Tobin’s Q is significant in the analyst fol-lowing regression, suggesting that endogeneity may be an issue. However,estimating the equations simultaneously, the relation between the analystcoverage ∗ family/management control interaction and Tobin’s Q remainshighly significant and, in fact, strengthens relative to the results in table 7.For example, in the model using family/management control percentage,the coefficient estimate increases from 0.0003 to 0.0005 for the non-Englishorigin subsample and from 0.0002 to 0.0004 for the low anti-director rightssubsample. Similarly, in the model using family/management as the largestblockholder, the coefficient increases from 0.0170 for non-English origin(0.0148 for low anti-director rights) when estimated using OLS to 0.0301for non-English origin (0.0257 for low anti-director rights) when estimatedsimultaneously. As with table 7, we find that the coefficients on the inter-action between analyst coverage and the two family/management controlproxies remain statistically different between the high- and low-protectionsubsamples in the simultaneous estimation framework.

4.8 SAMPLE-SELECTION ISSUES

An additional issue for our analysis is that of sample selection. Becausewe screen on firms with IBES coverage, our sample is restricted to firmsthat already have analyst following. Our discussions with First Call (formerlyIBES) suggest that it is not safe to assume that firms not included in itsdatabase do not have analyst following because IBES does not cover allfirms known to have analyst following. Because of this, we conduct ourprimary tests using the set of firms with existing IBES coverage. However,

21 For parsimony, we do not tabulate the simultaneous estimate results for the high-shareholder-protection subsamples. Consistent with the results in table 7, the coefficient onthe analyst coverage ∗ family/management control variable is not statistically significant.


T A B L E 8Simultaneous Equation Models in Low Shareholder Protection Countries

Three-stage least squares regression estimates of Tobin’s Q on analyst coverage and ownershipstructure and controls estimated on subsamples of countries with low shareholder protectionas measured by anti-director rights and legal origin. Anti-director rights values range from 0 to5 and are obtained from table 2 of La Porta et al. [1998]. Legal origin is categorized by whethera country’s legal system derived from English common law (La Porta et al. [1998]). Tobin’s Qis computed using data predominantly from fiscal year 1996 and is defined as total assets lessthe book value of equity plus the market value of equity in the numerator and book value ofassets in the denominator. Tobin’s Q is winsorized at the 1st and 99th percentiles. Ownershipvariables are defined in table 1 and other variables are defined in tables 2 and 4. The p-valueof the two-tailed t-test of equality of the coefficient to zero is reported in parentheses.

Panel A: Family/management control percentage and low shareholder protectionNon-English Legal Origin Anti-Director Rights < 4

Structural First-Stage Structural First-StageEquation Equation Equation EquationTobin’s Q Analyst Coverage Tobin’s Q Analyst Coverage

(1) (2) (3) (4)


Family/management control % −0.0020 −0.0430 −0.0013 −0.0411(0.23) (0.00) (0.45) (0.00)

Analyst coverage ∗ Family/ 0.0005 0.0004management control % (0.00) (0.01)

Debt/assets −0.1815 −0.0169(0.00) (0.66)


XLIST −0.0101 2.1589 −0.0530 3.1742(0.93) (0.18) (0.75) (0.17)

Firm size −0.1514 2.7643 −0.1376 2.7292(0.00) (0.00) (0.00) (0.00)

Country controls Yes Yes Yes YesIndustry controls Yes No Yes NoTobin’s Q 11.1285 13.7222

(0.00) (0.00)Float 0.3891 0.3311

(0.00) (0.00)Earnings growth 0.0900 0.0815

(0.50) (0.50)Return STD −0.0219 −0.0078

(0.04) (0.40)Return-earnings correlation 0.1014 −0.0098

(0.63) (0.96)Earnings surprise −0.0068 −0.0061

(0.23) (0.24)N 1,046 1,058

as an alternative research design, we include all firms for which ownershipdata are available and assign a zero value for analyst following if a firm wasnot covered in the IBES data set, which expands the sample to 3,855 firms.This analysis assumes that if the firm is not on IBES, it is likely to have only



Panel B: Family/management is largest blockholder and low shareholder protectionNon-English Legal Origin Anti-Director Rights < 4

Structural First-Stage Structural First-StageEquation Equation Equation EquationTobin’s Q Analyst Coverage Tobin’s Q Analyst Coverage

(1) (2) (3) (4)


Family/management is the −0.2718 −0.7193 −0.1857 −0.7226largest blockholder (0.01) (0.22) (0.06) (0.26)

Analyst coverage ∗ Family/ 0.0301 0.0257management is the (0.00) (0.01)largest blockholder

Debt/assets −0.1833 −0.0087(0.00) (0.81)


XLIST 0.0126 2.5115 −0.0103 3.4172(0.92) (0.13) (0.95) (0.15)

Firm size −0.1533 2.8768 −0.1373 2.8302(0.00) (0.00) (0.00) (0.00)

Country controls Yes Yes Yes YesIndustry controls Yes No Yes NoTobin’s Q 11.6903 14.3256

(0.00) (0.00)Float 0.4199 0.3522

(0.00) (0.00)Earnings growth 0.0840 0.0984

(0.54) (0.43)Return STD −0.0199 −0.0037

(0.07) (0.69)Return-earnings correlation 0.0354 −0.0597

(0.87) (0.75)Earnings surprise −0.0047 −0.0047

(0.41) (0.36)N 1,046 1,058

local analysts following the firm (or none at all). We find in all models thatour results (untabulated) are robust to this alternative research design.

In addition, it is of interest to know whether the relations we documentalso hold when analyst coverage is initiated. Our discussions with First Callsuggest that one way to assess this issue is to examine firms that are addedto the IBES database. Although not a perfect measure, firms are most oftenadded to the data set by virtue of initiation of analyst coverage. As a result,it is possible to compare valuation before and after IBES coverage as a noisyproxy for initiation of coverage. To this end, we gather data on firms thatwere added to IBES from 1992 to 1996 and measure how their valuationchanges upon the initiation of analyst coverage. To control for other factorsthat might have changed around initiation of IBES coverage, we implement


a two-stage approach where, in the first stage, we use our models that explainTobin’s Q to predict the expected Q value for each firm in the Worldscopedatabase from 1992 to 1996 that has the necessary ownership data. For thefirms that were added to IBES, we obtain the residuals from these models thatwere obtained from estimates using the full sample of firms. The residualscorrespond to the excess value for each added firm based on its overallfirm attributes. We then examine the change in excess value, defined as thedifference in the residual from the year before the firm was covered by IBESto the year coverage began.

Our tests (untabulated) examine whether the increase in excess value forfirms that gain analyst coverage is largest for firms located in poor share-holder protection environments. We find a significant increase in (residual)value around the initiation of analyst coverage of about 10% for firms locatedin countries with poor investor protection laws (45 firms). This finding holdswith similar magnitude for both specifications of firm-level governance, andthe difference is always significant. For firms in high-shareholder-protectionenvironments (94 firms), there is no significant change in value in the yearsaround initiation of IBES coverage. The difference in value change aroundinitiations between high- and low-investor-protection environments is sig-nificant at better than the 5% level in all specifications.

Results from this analysis suggest that firms in low-investor-protection en-vironments gain most from the initiation of analyst coverage, consistent withthe notion that analysts serve a monitoring role. However, the conclusionsfrom this analysis are subject to several caveats. Because our ownership dataare for 1996, we assume that managerial concentration of control is similarfrom 1992 to 1996. In addition, sample sizes are small and analyst initiationsare potentially measured with error.22

5. Conclusion

This paper examines the relation between analyst following and a firm’sinternal and external corporate governance environment, seeking evidenceon whether analysts play a potential role in corporate governance. We doc-ument that analysts are less likely to follow firms with poor internal gover-nance, such as when the family/management group is the largest controlrights blockholder. This finding is consistent with the hypothesis that con-trolling managers may wish to withhold or manipulate information to con-ceal their private benefits of control from other shareholders. We also findthat this effect is more pronounced when external shareholder protectionis weak.

22 Although we cannot rule out measurement error, comparing the effect of initiations be-tween low- and high-shareholder-protection environments should mitigate the omitted effectof correlated variables associated with IBES coverage and valuation. For example, if IBES ini-tiates coverage for some other reason correlated with firm value, this would likely affect bothsubsamples.


We conduct valuation tests and find that the interaction of analyst cov-erage and concentrated family/management control is positively relatedto firm value, but only among firms from countries with poor externalshareholder protection. This result suggests that analysts are particularlyimportant for firms with controlling families/managers in environmentsin which legal institutions provide relatively poor protection for minorityshareholders. Overall, our findings suggest that corporate governance playsan important role in analysts’ willingness to follow firms and that increasedanalyst following is associated with higher valuations, particularly for firmslikely to face governance problems.

These results suggest the potentially important role of analysts in gover-nance. In particular, like securities regulators and auditors, analysts have theability to enhance transparency. Unlike auditors, however, analysts are notdirectly chosen by management. As a consequence, analysts have the poten-tial to provide an additional layer of oversight. However, analyst following,ownership structure, and legal protection appear to be complements froma governance perspective in that firms in environments with better share-holder protections tend also to have less concentrated ownership and moreanalyst following.

Although in a different context, the preceding result is generally consis-tent with research such as Hail and Leuz [2003], who find that regulateddisclosure and enforcement are complements in determining cost of capital.Furthermore, they find that the benefits of disclosure and enforcement areattenuated for more fully integrated markets. Similarly, Bushman, Piotroski,and Smith [2003b] suggest that analyst following tends to be lower in en-vironments with weaker insider trading enforcement, where analyst infor-mation production could be particularly beneficial. Again, the effects ofinsider trading enforcement on analyst following is greater in common lawregimes where there are other investor protections in place. Overall, thisbody of research highlights the possibility that deficiencies in one aspect ofgovernance may not be naturally offset by the substitution of others. Fur-ther research in alternate governance mechanisms for firms is likely to befruitful.

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