Analyst Independence and Earnings Management

Abstract

We examine whether analyst independence contributes to analysts’ monitoring role in deterring accruals earnings management. We first report a negative association between earnings management and the ratio of independent analysts to brokerage analysts covering a firm. Next, through the lens of the promotion of independent sell-side research institutions by the 2003 Global Research Analyst Settlement, we document a significant decrease in earnings management on firms affected by the Global Settlement’s mandate for time-limited support to back independent research institutions. Additionally, we find that, as the aforementioned support ended, the extent of monitoring effectiveness reverted to a level indistinguishable from that before the Global Settlement. Finally, using closures and mergers of independent research institutions as a quasi-natural experiment, we provide corroborating evidence consistent with analyst independence leading to more effective monitoring.

Keywords: analyst independence, monitoring, earnings management, regulatory reforms

JEL Classification: G34, K22