SMALL FIRM GOVERNANCE AND ANALYST FOLLOWING

IA study extends the literature on analyst behavior by examining the relationship between corporate governance and the degree of analyst following for small US firms. The study sampled 365 small firms (using the same size definition as that used in creating the S&P 600 Small Cap Index) that have necessary I/B/E/S, Research Insight, and corporate governance data for the year 2002. The study focused on small firms because: 1. they have particular difficulty in attracting analysts' attention; and 2. given the limited coverage of small firms in the financial press, analyst coverage of them is arguably more important in mitigating the information asymmetry problem between managers and outside shareholders. Our measure of corporate governance quality is broad and has been used in many recent studies. However, this is the first study (to our knowledge) that relates a comprehensive measure of corporate governance quality to analyst coverage. After controlling for a variety of firm-specific factors that could influence analysts' incentives to provide coverage, we find that firms with stronger corporate governance are followed by a greater number of analysts. We argue that analysts prefer to cover firms with better governance because these firms have lower expected agency costs and higher expected financial disclosure quality.