This paper discusses the relationship of financial analysts and managers equity decisions.

It

examines the influence analysts have on management and whether they serve as external

monitors to managers or whether they provide excessive pressure to managers. Yu (2007)

provides empirical evidence on the relationship between analysts and management

including their influence on earnings management. To carry out the empirical tests, Yu

(2007) adopted two instrument variables, change in broker size and the firms inclusion in

the S and P 500 index.

Financial analysts require suffice and accurate information on companies to ensure any

clients or employers of investment banks are provided with the closest predictions. In

particular they may be concerned with every small financial detail within the financial

reporting due to the incentives in place for them. If and when there are earnings release

conference calls, analysts are provided with the opportunity to ask a wide spectrum of

questions about the company’s financial position and any changes in revenue. These

analysts further express their concerns about covered firms, through their research reports

to clients and any forecasts to investors.

Analysts also contribute to the involvement of discovering any corporate fraud in a number

of companies. A survey undertaken by Rajgopal (2005) of 401 financial executives suggests

that analysts have a significant influence as 90% of managers would agree that their most

important group when setting the share price is the analysts. Prior literature by Healy and

Palepu (2001) also suggests that information intermediaries such as analysts and rating

agencies engage in private information production that helps detect manager’s behaviours.
Managers tend to complain when analysts provide alot of pressure as they state that the

most important goal is to meet analysts expectations about earnings. Also, managers

believe they receive excessive about of pressure when analysts themselves are receiving

pressure from other sources which could effect their own personal incentives. Also, it is

thought that analysts are less likely to issue negative opinions when major clients have

significant holdings in certain companies. As an external monitor analyst a firms earnings

management behaviour could decrease as the number of analysts following the firm

increases. Excessive pressure on the other hand could result in a firms earnings

management increasing. Although, there could also be no role between the analyst

coverage and earnings management.

The empirical results show that the effect of analyst coverage is stronger for analysts who

make better forecasts, including those from top brokerage houses and those with more

experience.