Do Financial Analysts Add Value by Facilitating More Effective Monitoring of Firms' Activities?

Researchers argue that analysts' information acquisition efforts increase firm value by facilitating monitoring of firms' activities and, thereby, reducing agency costs (e.g., Jensen and Meckling [1976]; Healy and Palepu [2001]). However, prior research provides limited and inconclusive empirical evidence to support this argument. This paper extends the literature by: examining the relation between analyst following and the value of firms' equity securities; and given a positive relation, whether that relation reflects effectively enhanced monitoring of firms' activities as a result of analysts' information acquisition efforts. We document a positive relation between analyst following and firms' asset values, and we find support for two hypotheses regarding the source of the increased asset values. First, the cash component drives the positive relation between analyst following and asset values. We interpret this evidence to imply a stronger monitoring effect for assets that are subject to higher agency costs or information asymmetry. Second, consistent with analyst following constraining asset mismanagement or motivating more efficient asset use, operating performance and total cash payout increase with analyst following. Overall, our results suggest that financial analysts facilitate more effective monitoring of firms' activities and, thereby, reduce agency costs and increase shareholder value