Abnormal Analyst Coverage, External Financing, and Firm Investment

Abstract

In this paper, we examine whether the external financing and investment rate of the firm are influenced by abnormal analyst coverage. We find that firms with high (low) excess analyst coverage have consistently higher (lower) external financing and investment rate than firms of similar size in the same industry. The results show that he impact of analyst coverage on firms' financing and investment decisions works through a direct mechanism that hypes investors' long-term growth prospects of the firm. Our evidence also demonstrates that firms with excessive analyst coverage realize lower future returns than firms with low analyst coverage. This finding is consistent with the hypothesis that analyst coverage is primarily motivated by the pay structure of analysts and investment-banking incentives that favor the coverage of firms with the potential to engage in profitable investment banking business (i.e., external financing).

JEL Classification: G30, G31, G32