Analyst Coverage and Earnings Management

Do analysts serve as external monitors to managers, or do they put excessive pressure on managers? This study examines the role analysts play in corporate governance by focusing on the effect that their scrutiny has on earnings management. Controlling for other firm characteristics, including institutional ownership, I find that firms followed by more analysts manage their earnings less. To address potential endogeneity problem of analyst coverage, I use two instrumental variables that are based on change in brokerage house size and on firm’s inclusion in the S&P 500 index, and find that the result is robust. The effect is stronger for analysts from top brokers and for more experienced analysts. In addition, the effect is stronger for female analysts, who are likely to be more effective monitors for being outsiders of maledominated corporate community. 1 Graduate School of Business, University of Chicago. I would like to thank my advisors, Marianne Bertrand, Abbie Smith, Richard Thaler, and Luigi Zingales, for their guidance and support. I also thank Phil Berger, Henrik Cronqvist, Douglas Diamond, Eugene Fama, Raife Giovinazzo, Steven Levitt, Lan Shi, and the participants of finance seminar at the University of Chicago for valuable comments and suggestions. I gratefully acknowledge the contribution of Thomson Financial in providing analyst forecast data through I/B/E/S. This data is provided as part of a broad academic program to encourage earnings expectations research. Research support from the Oscar Mayer Foundation is gratefully acknowledged. All the errors are my own. Please send correspondence to: Frank Yu, Graduate School of Business, University of Chicago, 5807 South Woodlawn Avenue, Chicago IL 60637, phone: (773) 220-5577, email: [email protected].