Corporate Strategy and Analyst Incentives: Do Capital Markets Encourage or Discourage Uniqueness?

Our paper focuses on how the relationship between corporate strategy and securities analyst activity may yield capital markets which discourage uniqueness in strategy. We argue that corporate strategy choices influence not only the expected cash flows of the firm, which form the fundamental basis for the firm’s valuation by capital markets, but also the amount of effort exerted by those who engage in such valuations. In particular, the effort of analysts and the willingness of investment banks to allocate analyst coverage are partly a function of the cost of that coverage, which in turn is a function of how difficult it is to analyze a corporation’s strategy. When analysis is particularly costly, investment banks may either choose to compromise on the quality of coverage or avoid coverage altogether, reducing the amount of information about the firm that is available to investors. Unique or complex corporate strategies are thus predicted to receive less coverage and correspondingly to be discounted by capital markets. We empirically test this proposition using a 10-year panel dataset linking approximately 14,000 firms from Compustat’s Industrial and Segment files between 1990 and 2000 with their corresponding analysts who appear in the I/B/E/S Detail History file.