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 Can companies buy credible analyst research?*
Marcus Kirk*
Goizueta Business School, Emory University, 1300 Clifton Road, Atlanta, GA 30322, USA
Version: September 8, 2008
Abstract
The benefits of analyst coverage are well documented but the majority of publicly tradedcompanies do not have coverage. In this paper, I explore a controversial mechanism recommended by anSEC advisory committee by which companies can acquire coverage
 – 
paying for it.I find firms that pay for research have greater future performance uncertainty, higher informationasymmetry, and lower visibility. I find that 2-day cumulative abnormal returns are significantly related tothe issuance of paid-for reports suggesting they have information content for investors despite theinherent conflicts of interest. After the initiation of coverage, companies experience an increase inliquidity, institutional ownership, and sell-side analyst following.However, paid-for coverage is neither a perfect substitute for sell-side coverage norunconditionally valuable. Paid-for analysts issue relatively less accurate forecasts and more optimisticrecommendations than sell-side analysts. In addition, the results are strongest for fee-based research firmswith ex ante policies that reduce potential conflicts of interest and enhance credibility.
Keywords:
Analyst coverage, voluntary disclosure, capital markets, credibility
* I thank Jan Barton, Marty Butler, Stan Markov, Grace Pownall, Greg Waymire and workshop participants at theEmory Archival Brown Bag for helpful comments. I am grateful for the financial support of the Roberto C. GoizuetaFoundation.*Contact information: Tel.: +1-404-396-5997; fax: +1-404-727-5337.
 Email address
: marcus_kirk@bus.emory.edu
 
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Introduction
This study examines whether paying for analyst research has value to investors and the companypurchasing research. While the existing literature suggests analysts are important informationintermediaries, it is unclear whether the inherent conflicts of interest in paid-for research preclude it as aviable alternative to traditional sell-side analyst coverage. This question has become particularlyimportant as economic and regulatory changes over the last decade such as the minimum bid-ask spread,Reg FD, SOX, and the Global Settlement have accelerated the drop in sell-
side analysts’ coverage of 
small- and mid-cap stocks (Leone, 2004).
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Lack of analyst coverage is a pervasive empirical regularitythat affects the majority of publicly listed firms. Citing the adverse effects for individual companies fromthis lack of coverage, an SEC Advisory Committee recently encouraged the use of paid-for research as away for firms to access the benefits of analyst coverage. However, there is no empirical evidenceexamining the viability of this controversial equity research model.
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 In paid-for research, companies hire a fee-based research firm to prepare one or many reports.Paid-for and sell-side analysts may perform many similar functions as information intermediaries. Forexample, paid-for analysts interpret past events and perform prospective analysis; evaluate businessmodels; and communicate this analysis by writing reports, which often include a business overview,earnings forecasts, price forecasts, and a recommendation level. More generally, by providing publicinformation they can
help aid investors’ decisions in allocating resources across securities and make the
market more efficient while also providing benefits for the covered company such as increased liquidityand lower cost of capital (Healy and Palepu, 2001; Barth and Hutton, 2004; Irvine, 2003).
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Bushee and Miller (2007) find that investor relations professionals view Reg FD and SOX as decreasing theanalyst following of small and mid-cap firms and that attracting analysts for these firms is unlikely. In particular,analysts told the IR professionals that their clients lack the trading volume (and thus commissions) to warrantcoverage.
 
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For example, Lang et al. (2004) find analysts tend not to cover firms with severe agency problems despite the fact
that these firms may benefit the most from the monitoring effect of analyst coverage. They state “It’s possible some
managers of firms with concentrated ownership might prefer to have greater analyst following but do not have a
ready mechanism with which to attract analysts.”
 
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Despite the potential benefits of analyst coverage, some view paying for research withskepticism. Critics allege that the inherent conflict of interest robs the research of any value
and “is one of the most scurrilous practices in investor hyping” (Metzger 
, 2003). Paid-for analysts may feel pressure tooptimistically bias their forecasts and recommendations in order to encourage the client to renewcoverage. Beyond the research funding conflict, paid-for analysts may have neither the ability nor theexperience necessary to provide any new or valuable information.The goal of this study is to provide evidence on the role of paid-for research. To do this Iexamine 10 fee-based firms from 1999 to 2006; including the top five firms in the industry. I hand-collectover 6,000
analyst reports from the research firms’ webs
ites and archives. I identify over 500 US firmsthat purchased coverage over this period, reflecting the burgeoning demand for paid-for research amongfirms with little or no analyst coverage.First, I provide descriptive evidence of what types of companies buy research and model a
company’s decision to
pay for analyst coverage. I find that managers are more likely to buy analystcoverage for firms: that are younger; that are smaller; whose businesses depend on intangible assets;engaging in mergers or acquisitions; with more growth opportunities; and with more volatile stock returns. This is consistent with the notion that firms with weaker information environments, lowervisibility, higher information asymmetry between insiders and outsiders, and greater uncertainty aboutfuture earnings and cash flows have the most to gain from analyst coverage and reducing this uncertainty(Lang et al., 2001; Botosan, 1997) but at the same time are unlikely to attract sell-side analysts asbrokerages are loathe to devote effort and resources to firms with difficult-to-predict future earnings andcash flows (Bhushan, 1989; Barth et al., 2001). Likewise, I find firms with low share turnover are morelikely to buy analyst coverage as sell-side analysts are unlikely to generate enough commissions to justifycovering small, thinly traded stocks (Irvine, 2003; Bushee and Miller, 2007). Finally, I find that buyinganalyst coverage is negatively associated with institutional investor ownership and sell-side coverage andpositively associated with prior stock returns and future financing.
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