The Investigation of the Relationship among Analyst Following, Managerial Ownership and Firm Valuation: From the Perspective of Agency Theory

In this study, the relationship among analyst following, managerial ownership and firm valuation is investigated from the perspective of agency theory by using a nonlinear simultaneous equation model. The data from the Taiwan stock market verify the proposed hypotheses with a nonlinear three-stage least-square procedure. The empirical results show that managerial ownership (serving an internal monitoring function) and number of analysts following (serving an external monitoring function) are respectively nonlinear and linear increasing functions of firm valuation, while managerial ownership and analyst following are substitutes in the monitoring of the firm. The results generated from this study support an alignment effect and an entrenchment effect in the relationship between managerial ownership and firm valuation after controlling for the effect of analyst following. Evidence also shows that analyst coverage serves to enhance firm valuation after controlling for the effect of managerial ownership. In addition, a substitution effect between number of analysts following and managerial ownership is found to exist as well as a decreasing marginal value for managerial ownership. It is indicated that both security analysts and managerial ownership serve as monitoring forces in the firm and higher level of monitoring forces, whether internal or external, will enhance firm valuation. The results reveal that the security analysts serve the external monitoring function by reducing the agency cost associated with the separation of ownership and control in the Taiwan stock market.