Lerner Research: Analysts With Industry Experience Make Better Fraud Watchers
Fei Xie, a researcher from University of Delaware’s Lerner College recently co-authored a study that indicated that analysts with industry experience make better watchdogs for CEO’s.
The study, reported in the Wall Street Journal, involved analyzing reports by nearly 5,000 analysts from 6,391 firms from 1988 to 2011. The study states, “Our collective findings indicate that industry-expert analysts provide external monitoring of firm managers and improve corporate governance.”
Professor Xie further explains that, “We examine multiple outcomes of corporate governance, including the extent of earnings manipulation and probability of committing financial fraud, CEO compensation and CEO turnover decisions …We find broad support that coverage by expert analysts improves these governance measures.”
This was the expected outcome according to the “effective-monitor hypothesis,” which indicates that analysts who have worked in an industry will be better equipped to assess CEO pay packages. However, the “impaired-monitor hypothesis” opposes this theory, suggesting that industry experience could lead to increased sympathy in analysts and could mean the analyst had contacts that would create bias.
Fei Xie’s study, which was co-authored with Daniel Bradley, Sinan Gokkaya and Xi Liu, indicates that the former “effective-monitor hypothesis” is generally accurate. According to the Wall Street Journal article, Xie’s study examines “quality of firms’ financial disclosures, CEO compensation and CEO turnover.” This separates the study from other research, which has focused on how industry experience improves analysts’ success in areas like earnings and stock recommendations.
The study’s findings indicate that companies covered by analysts with industry experience had fewer incidences of exorbitant CEO salaries and were less likely to keep on CEO’s who were not performing well. These analysts were also 31 percent more likely to address issues with corporate governance.
Professor Xie also addresses what this means for analysts in the future, asserting that, “It clearly makes sense for brokerage firms to emphasize industry experience in hiring and assigning analysts.”
