Chapter 1 provides evidence on the governance role of analysts’ recommendation ratings in CEO compensation and turnover. We find that a favorable change of recommendation rating of the stock is associated with an increase in three measures of CEO compensation (annual bonus, salary and bonus, and total compensation), and that an unfavorable recommendation rating increases the likelihood of CEO turnover. These relations are weaker for upgrades than for downgrades, consistent with the optimistic bias in analysts’ recommendations. We also find that the effect of recommendation change on CEO pay is stronger for firms with better corporate governance. Further, we document a decrease in the relation of CEO pay with recommendation change following the implementation of the Sarbanes–Oxley Act of...[ Read more ]

Chapter 1 provides evidence on the governance role of analysts’ recommendation ratings in CEO compensation and turnover. We find that a favorable change of recommendation rating of the stock is associated with an increase in three measures of CEO compensation (annual bonus, salary and bonus, and total compensation), and that an unfavorable recommendation rating increases the likelihood of CEO turnover. These relations are weaker for upgrades than for downgrades, consistent with the optimistic bias in analysts’ recommendations. We also find that the effect of recommendation change on CEO pay is stronger for firms with better corporate governance. Further, we document a decrease in the relation of CEO pay with recommendation change following the implementation of the Sarbanes–Oxley Act of 2002, which strengthened boards’ incentives. In sum, our results on the governance role of recommendation ratings are consistent with the theory of collusion in organizations (Tirole 1992).

Chapter 2 provides evidence on whether financial analysts’ conflicts of interest contribute to overvaluation around financing activities and help explain the negative relation between external financing (equity or debt) and future stock returns reported in Bradshaw, Richardson, and Sloan (2006). We predict that corporate external financing is positively related with analysts’ optimism in earnings forecasts and stock recommendations, but the relation is weaker following the enactment of NASD Rule 2711 in 2002 that prohibit tying analysts’ compensation to investment banking business. We further predict that the negative relation between external financing and future stock returns is weaker in the post-Rule period. Employing a large sample of observations from 1994 to 2010, we report empirical results that are consistent with these predictions. We further show that the weaker relations in the post-Rule period are attributable to improved analyst independence. Finally, we show that the predicted changes remain after controlling for accrual anomaly. Taken together, our empirical results suggest that analysts’ conflicts of interest play a role in overvaluation around corporate financing activities and at least partially explain the negative relation between external financing and future stock returns.