Do Firms Use M&A Business to Pay for Analyst Coverage?

Published date01 November 2013
Date01 November 2013
DOIhttp://doi.org/10.1111/fire.12022
The Financial Review 48 (2013) 725–751
Do Firms Use M&A Business to Pay
for Analyst Coverage?
Valeriy Sibilkov
University of Wisconsin – Milwaukee
Miroslava Straska
VirginiaCommonwealth University
H. Gregory Waller
VirginiaCommonwealth University
Abstract
We find that acquirers in merger and acquisition (M&A) transactions are more likely to
hire as advisors investment banks that provided analyst coverage for the acquirer prior to the
transaction. Wealso find that compared to a matched control group of banks, the advisor banks
are less likely to terminate and more likely to initiate analyst coverage of the acquirer after
the transaction. Finally, the advisor banks that initiate coverage after the transaction collect
higher fees. These findings suggest that firms value analyst coverage and use M&A advisor
appointments and advisor fees to compensate for it.
Keywords: mergers and acquisitions, analyst coverage, financial advisors
JEL Classifications: G24, G34
Corresponding author: Virginia Commonwealth UniversitySchool of Business, 301 West Main Street,
P.O. Box 844000, Richmond, VA 23284-4000; Phone: (804) 828-3365; Fax: (804) 828-3972; E-mail:
hgwaller@vcu.edu.
We appreciate helpful comments from David Denis, David Ikenberry, Lilian Ng, Geoffrey Smith, and
finance seminar participants at University of Wisconsin – Milwaukee. This paper previously circulated
under the title “AreFinancial Advisor Appointments in Mergers and Acquisitions Used to Pay for Analyst
Coverage?”
C2013 The Eastern Finance Association 725
726 V.Sibilkov et al./ The FinancialReview 48 (2013) 725–751
1. Introduction
It is well established in the finance and accounting literature that analyst
coverage provides valuable economic benefits to firms. These benefits include in-
creased visibility (Merton, 1987), reduced information asymmetries (Easley, O’Hara
and Paperman, 1998; Easley and O’Hara, 2004), increased liquidity (Brennan and
Subrahmanyam, 1995), and reduced agency costs (Moyer, Chatfield and Sisneros,
1989; Lang, Lins and Miller, 2004). Given the benefits associated with analyst cov-
erage, it follows that firms should be willing to allocate economic resources to
compensate for it.
In at least one setting, it is clear how this is done. Kirk (2011) examines the
increasingly common practice of “paid-for coverage” whereby companies hire a fee-
based research firm to prepare one or many equity analyst reports. Kirk documents
that firms with greater uncertainty, weaker information environments, and low share
turnover are firms that are less likely to attract traditional sell-side analyst coverage
and, therefore, are more likely to buy paid-for analyst coverage. One of his key
findings is that firms that buy paid-for analyst coverage realize economic benefits,
despite the inherent conflicts of interest.
Although it is widely believed that all analyst coverage is paid for in some man-
ner,1it is less clear how firms compensate for traditional sell-side analyst coverage.
Prior research suggests that analyst coverage has a significant influence on a firm’s
choice of investment bank for underwriting its initial public offering (IPO) and sub-
sequent seasoned equity offering (SEO). Krigman, Shaw,and Womack (2001) report
survey evidence that improved research coverage is a key factor in a firm’s decision
to switch underwriters between its IPO and SEO. Cliff and Denis (2004) provide
evidence that firms strategically underprice IPOs to compensate investmentbanks for
high-quality analyst coverage and that the probability that firms switch underwriters
between their IPO and subsequent SEO is negatively related to the amount of post-
IPO analyst coverage.2The findings in these studies imply that new publicly traded
firms value sell-side analyst coverageand compensate investment banks for providing
it by awarding SEO underwriting business and through IPO underpricing. However,
these studies leave unexplored the question of whether public firms try to obtain and
compensate for sell-side analyst coverage later in their lives, and if so, how.
We examine whether acquiring firms in merger and acquisition (M&A) trans-
actions use M&A advisor appointments or M&A advisory fees to compensate
1See, for example, the remarks of John Dutton of Dutton Associates, a fee-based research firm, who
argues that “all research is paid for in one way or another, whether it is by commissions generated within
a brokerage firm or investment banking fee. . . ” (Brooks, 2006, p. 34).
2See also Aggarwal, Krigman and Womack (2002) for additional IPO underpricing evidence consistent
with the argument in Cliff and Denis (2004) that firms use IPO underpricing to compensate for analyst
coverage.

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