Governance Role of Analyst Coverage and Investor Protection

This study examines whether investor protection affects the governance role of analysts in constraining earnings management. Using a sample of 50,966 company-year observations from 24 countries for 1990–2007, the study finds that earnings management is more negatively associated with analyst coverage in weak investor protection countries than in strong investor protection countries. The findings suggest that analyst coverage plays a more important governance role in countries where investor protection is weak (i.e., a substitute relationship exists between analyst coverage and investor protection). In examining the relationship between analyst coverage and earnings management, recent research has found that high analyst coverage is associated with less earnings management in the United States, suggesting that analyst coverage can play a governance role in capital markets. The research on analysts’ governance role is limited, however, especially in an international context. This study examines whether investor protection affects the governance role of analysts in constraining earnings management.Using a sample of 50,966 company-year observations from 24 countries for 1990–2007, I found that earnings management is more negatively associated with analyst coverage in weak investor protection countries than in strong investor protection countries. The results are robust to several additional analyses. My findings suggest that analyst coverage plays a more important governance role in countries where investor protection is weak (i.e., a substitute relationship exists between analyst coverage and investor protection).This study contributes to the literature in two ways. First, it extends the limited research on the governance role of analysts. It focuses on international data and the impact of investor protection on analysts’ governance role. By examining the relationship between analyst coverage and earnings management in an international context, this study provides further evidence on the substitute relationship between analyst coverage and investor protection and thus expands the research on the international governance role of analysts. Second, it adds to the growing literature on international analysts. Prior research has focused on investigating the effect of country-level institutions on analyst coverage and forecast accuracy. This study extends that research by examining the relationship between investor protection and the effectiveness of analyst coverage in constraining earnings management.