The Effect of Institutional Investor Distraction on Analyst Forecasts

Abstract

We find that financial analysts prioritize monitoring overlooked firms, demonstrating a commitment to comprehensive forecasting for companies with less engaged institutional investors (referred to as “distracted”) rather than solely focusing on trading commissions. To establish a causal link between institutional investor distraction and analyst coverage, we analyze external factors influencing this distraction, building on the approach outlined by Kempf, Manconi, and Spalt (2017). Our findings indicate a heightened manifestation of this trend in firms characterized by deficient corporate governance or limited information environments, particularly among analysts associated with smaller brokerage firms. Additionally, analysts exhibit a tendency to issue more pessimistic earnings forecasts and stock recommendations for companies facing distracted institutional investors, possibly signifying an intention to hold errant firm managers accountable.
Overall, our study underscores financial analysts’ pivotal role in corporate governance mechanisms and sheds light on their behavioral and prioritization patterns.

Keywords: financial analysts, investor attention, institutional investors, corporate governance

JEL Classification: G10, G14, G17, G23, G34