CLASES DE ESTRUCTURAS CURRICULARES.

In summary, firms’ corporate strategy may influence analysts’ coverage decision through two channels: 1) an association with the level of ex ante information asymmetry, and 2) an association with the frequency of firms’ discretionary disclosures.8 _{The two impacts}

affect analysts’ choice to follow a firm through competing effects on demand for analyst services and the cost of supplying those services. A summary of the expected prediction are provided in the following table.

Summary of the Predictions of Strategic Impacts on Analyst Coverage

Prospectors VS other firms

High IA High Demand +ve Coverage

High Supply Cost -ve Coverage

High DD Low Demand -ve Coverage

Low Supply Cost +ve Coverage

7_{It is also possible that, the quality (as well as the quantity) of voluntary disclosure differ by strategic types,}

and that this in turn, impact analysts’ decision to follow a firm. Bentley et al. (2013) find that Prospectors have more frequent financial statement irregularity than Defenders, as measured by shareholder lawsuits, SEC enforcement actions and accounting restatements. Higgins et al. (2015) provide evidence that Prospectors are more aggressively engaged in tax-avoidance behaviours including low book and cash effective tax rates (ETRs), higher permanent book-tax differences, more additions to uncertain tax benefits and operations in tax haven countries. To test the propositions related to the mediating effect of voluntary disclosures on the relationship between corporate strategy and analyst coverage, I perform additional tests of mediation effect using three proxies of voluntary disclosures: numbers of earnings guidance issued, accrual quality and bog index (Bonsall et al. 2017) which capture both the quantitative and qualitative effects of voluntary disclosure.

8 _{Apart from impacts derived from firm characteristics, analysts may have self-interested incentives to}

cover Prospectors rather than all other firms because of the potential investment banking business they can bring to their employers. I predict the first hypothesis excluding the strategic impacts from investment banking incentives. I will provide more discussions and predictions for investment banking incentives in a later section.

43 Defenders VS other firms

Low IA Low Demand -ve Coverage

Low Supply Cost +ve Coverage

Low DD High Demand +ve Coverage

High Supply Cost -ve Coverage

Thus, when analysts are considering whether to cover a Prospector, the greater demand arising from high information asymmetry, and the reduced cost of supply resulting from firm’s greater discretionary disclosure each should increase coverage. Whereas, greater coverage of Defenders may result from the lower cost of supply associated with low ex ante information asymmetry and / or greater demand arising from limited discretionary disclosures. Thus, if the aforementioned factors dominate the theoretically competing effects (e.g. higher supply cost due to ex ante information asymmetry for Prospectors), it is possible for analysts to cover both Prospectors and Defenders more than ‘other firms’ (the Analysers and Reactors). However, given that Bentley-Goode et al. (2017) find that coverage is increasing in the extent to which firms display Prospector-like attributes, I propose two maintained hypotheses that are consistent with their findings.9 Thus, H1Fp and H1Fdpredict that:10

H1Fp: Prospectors receive greater analyst coverage than ‘other firms’ within the same

industry.

H1Fd: Defenders receive lower analyst coverage than ‘other firms’ within the same

industry.

9 _{Bentley-Goode et al. (2017) frame their hypotheses around the levels of an ordinal variable increasing in}

the extent to which firms resemble Prospectors. My study follows earlier research and focuses on groups of firms defined by the levels of the ordinal strategy measure. Further details are provided in the methodology section of this study.

10 _{The suffixes in my hypothesis names indicate the level at which strategic types are identified (F = firm-}

level; I = industry-level), and the strategic types that are the focus of the hypothesis (p = Prospector; d = Defender).

44

Although firm’s strategic choices may induce two competing effects on the analyst coverage decision, the results from the hypothesis tests may potentially indicate the relative strengths of each effect. If I find Prospectors receive more coverage than ‘other firms’ (Analysers and Reactors) and Defenders, this would provide evidence that either (or both) the ‘demand effect’ dominates the strategic impact of ex ante information asymmetry and/or the ‘supply effect’ dominates the voluntary disclosure impact of the firm’s strategic choices on the analyst coverage decision. If, counter to prediction, I find that Defenders receive more coverage than ‘other firms’ and Prospectors, this would suggest that the strategic impact of ex ante information asymmetry is dominated by the ‘TC effect’ and the strategic impact of voluntary disclosure is dominated by the ‘Demand effect’.

I later develop hypotheses concerning coverage by expert analysts designed to shed further light on the driving forces behind the coverage decision.

3.1.1.4. Industry Strategic Orientation

In addition to individual firms’ strategic choices, entire industries may exhibit strategic tendencies, which may affect the likelihood that analysts cover their constituent firms. The management literature recognises that the impacts of corporate strategy are not restricted to firm’s strategic choices, but are also jointly determined by industry characteristics (e.g. Porter 1980, Carroll et al.1992 and Amit and Schoemaker 1993). Amit and Schoemaker (1993) explain how strategic decisions conditioned by industry characteristics affects the riskiness and profitability of a firm. They argue that the profitability arising from a firm’s sustainable competitive advantage is determined by strategic choices in managing resources and developing capabilities. The identity of the particular resources and capabilities required for success frequently differ across industries (Amit and Schoemaker 1993, p.36). The industry-specific characteristics that

45

affect how firms in an industry optimally manage resources and develop capabilities are referred to as “Strategic Industry Factors”, and are defined as the strategic choices “determined at the market level through complex interactions among the firms’ competitors, customers, regulators, innovators external to the industry, and other stakeholders” (Amit and Schoemaker 1993, p.36). Because the market is imperfect and subject to causes of market failures, such as moral hazard (Akerlof 1970), asset specialisation (Klein et al. 1978) and sunk costs (Caves et al. 1984), asymmetric distributions of resources and capabilities across firms occur, which affects the profitability of some firms in the industry more than others. Therefore, Amit and Schoemaker (1993) argue that the overlap between firms’ strategic choices and the SIFs is a key determinant of the profitability of individual firms. This indicates that the industry strategic factors affect the scope for profitability in the whole industry, and encourages a certain degree of common strategy across surviving firms. A successful corporate strategy that produces sustainable profitability should be developed by analysing the characteristics and dynamics of industry strategic factors and the firm’s strategic choices in an integrated manner (Carroll et al.1992). Thus, if firms in an industry tend to exhibit similar strategic traits, information related to the typical industry strategy and firm’s strategic congruence are crucial to valuation.

Miles and Snow’s (2003) strategic typology classifies firm’s strategic choices into four types (Prospector, Defender, Analyser and Reactor) within an industry. However, applying the theory developed by Amit and Schoemaker (1993), it appears plausible that industries may also possess strategic tendencies. I describe these tendencies as the ‘industry strategic orientation’. When an industry predominantly consists of traits that are consistent with a Prospector (Defender) strategy, it is defined as a Prospector-oriented (Defender-oriented) industry.

46

For example, the computer equipment industry (SIC code: 35-36) is a potential Prospector-oriented industry. The key industry strategic factors for computer industry are: 1) timely introduction of innovative products (Vessey 1991, Klingebiel and Joseph 2016) and 2) a flexible business process system (Eisenhardt and Tabrizi 1995 and Boons et al. 2013). Vessey (1991) suggests that the timing of product introduction has severe impacts on firms’ future profitability. For example, firms that delay the introduction of a high- technology product by six month than the market expected time of introduction, will suffer a 33% reduction in profits over a five-year period compared to firms that are on time (Vessey 1991). First-mover advantages and related impacts on customer switching- costs in this industry have been recognised for many years (Lieberman and Montgomey 1988, Kerin et al. 1992, Suarez and Lanzolla 2007 and Vecchiato 2015). Additionally, Eisenhardt and Tabrizi (1995) argue that rapid product innovation supported by a business model that support acceleration of the adoptive process are crucial to the firms’ survival. Therefore, firms in computer industry need to use a flexible strategic model to stimulate creativity and allows flexibility to improve the adoptive process. Consequently, these key strategic factors are consistent with the features of Prospector strategy (e.g. innovation focus and decentralised or organisational structure); and the strategic choices of firms in this industry cannot vary too far from these key factors if they are to survive.

Conversely, wholesalers and retailers of physical goods (SIC codes: 51-59) are more likely to be Defender-orientated. The key industry strategic factors for many of these firms are: 1) economies of scale (Lewis and Thomas 1990 and Burt 2010), and 2) retaining market share for key products (Segal-Horn 1987, Carroll et al. 1992 and Murray et al. 2010). Economies of scale reflect the efficiency with which a firm deploys its resources and develops capability to establish competitive advantage within an industry, and are achieved (for retailers) by increasing average store size and capital intensity (Lewis and Thomas 1990). This is consistent with the focus of a Defender strategy as

47

Defenders emphasis on production efficiency and price discrimination to deter competitors (Miles and Snow 2003). Further, success in the retail grocery industry relies on the market share a firm can obtain and the focus of its product range (Segal-Horn 1987 and Carroll et al. 1992). This behaviour is consistent with Defenders as they achieve growth by “penetrating deeper into their current market” (Miles and Snow 2003, p.38). Both of these Defender-like strategic factors in wholesale and retail industries implies that firms need to employ a strategy capturing these features to increase their likelihood of survival.

To sum up, the corporate strategy employed by a firm is jointly determined by management’s strategic choices within an industry and the strategic factors that constrain the profitability of that industry. Therefore, information about the industry strategic orientation is essential to the valuation of a firm and plausibly affects analysts’ decision to follow firms in an industry. In reality, analysts are observed to cluster their coverage by industry to develop a specialisation in a particularly industry. It is also evident (e.g. in I/B/E/S) that analysts issue industry-level stock recommendations upon the demand of their employers.11 Additionally, investors value industry information and analysis that analysts provide. In particular, hedge funds and mutual funds are analyst’s biggest clients and they extremely value the industry knowledge and information sell-side analysts produce (Brown et al. 2015). As an important characteristic of an industry, the information about industry strategic orientation should have an impact on analysts’ choice to cover firms in an industry and this may help analysts to improve their ranking and reputation among investors (Mikhail et al. 2004, Leone and Wu 2007 and Emery and Li 2009).

11 _{The industry recommendation refers to analysts’ opinion on the outlook of a particularly industry. This}

is recorded in the “etext” field in the I/B/E/S recommendation file. The field contains the text of the firm recommendation and the industry recommendation separated by a slash if the brokerage is issuing industry recommendation. Examples for industry recommendation can be “attractive” or “cautious”.

48

Applying the same logic as in previous sections, average industry strategic orientation should have the same set of effects on the analyst coverage decision as the impacts from firms’ strategic choices. Thus, the two aspects that the industry strategic orientation may affect the numbers of analysts follow an industry are: 1) the average level of ex ante information asymmetry, 2) the average frequency and quality of firm’s voluntary disclosures. The competing ‘demand’ and ‘supply’ effects documented in the previous section may also exist the industry level. For a Prospector-oriented industry, demand is encouraged due to the level of ex ante information asymmetry; and supply costs are lower due to greater voluntary disclosure. Consequently, I propose two hypotheses regarding the impacts of industry strategic orientation on analyst coverage, consistent with the firm strategy-level predictions developed above:

H1Ip: Firms in a Prospector-oriented industry receive greater analyst coverage than

firms in ‘other industries’.

H1Id: Firms in a Defender-oriented industry receive lower analyst coverage than firms in

‘other industries’.