Concentrated Shareholders as Substitutes for Outside Analysts

Abstract

We contend that there is a governance substitution effect, with concentrated shareholders substituting for the monitoring activities of analysts. Our results are consistent with the opinion that regulators need not fear large shareholders. This is especially applicable to large outside shareholders as we find that the economic effect of concentrated outsider shareholdings is quite strong and greater than that of concentrated insider shareholdings. Our results support the argument that an outsider with a larger stake in a firm is more likely to produce its own in-house information for the monitoring of the firm's managers and avoid both the cost and moral hazard problems associated with analysts. The results also support the argument that if senior managers hold large stakes in the firm, there is a greater likelihood that managerial incentives will be aligned with those of other shareholders. Using a clean ownership dataset with a sample of 3,115 firm-year observations for U.S. firms and regression techniques that address any potential endogeneity, we find that analyst following is negatively related to the concentration of outsider and insider shareholdings. We find similar relations for changes in analyst following and changes in ownership concentration. We examine the relationship of concentration of shareholdings with the number of financial analysts following a firm to see if concentrated shareholders substitute for the monitoring activities of analysts. We examine the relationship of concentration of shareholdings with the number of financial analysts following a firm to see if concentrated shareholders substitute for the monitoring activities of analysts. Using a clean ownership dataset with a sample of 3,115 firm-year observations for U.S. firms and regression techniques that address any potential endogeneity, we find that analyst following is negatively related to the concentration of outsider and insider shareholdings. We find similar relations for changes in analyst following and changes in ownership concentration. Our results support the argument that an outsider with a larger stake in a firm is more likely to produce its own in-house information for the monitoring of the firm's managers and avoid both the cost and moral hazard problems associated with analysts. The results also support the argument that if senior managers hold large stakes in the firm, there is a greater likelihood that managerial incentives will be aligned with those of other shareholders. We contend that there is a governance substitution effect, with concentrated shareholders substituting for the monitoring activities of analysts. Our results are consistent with the opinion that regulators need not fear large shareholders. This is especially applicable to large outside shareholders as we find that the economic effect of concentrated outsider shareholdings is quite strong and greater than that of concentrated insider shareholdings.