Can Analysts’ Forecasts and Recommendations Affect Abnormal Compensation of CEOs?

Jensen and Meckling (1976) claim that by facilitating monitoring of firms’ activities, security analysis by financial analysts can reduce agency costs between management and external capital providers, and thereby increase shareholder value. Additionally, boards are required to design executive pay structures to minimize agency problems and related costs. Among the limited studies, that explore the relation between analysts’ favourable forecasts or recommendations and CEOs’ compensation, one strand reports a positive relation supporting the agency theory, while the other reports a negative relation contradicting the agency theory. This disagreement may stem from the unobserved determinants of CEOs’ compensation structures. Thus, we use CEOs’ abnormal compensation (ACOMP, the proportion of pay that economic determinants cannot accurately determine) to reinvestigate this relation and find conclusive evidence of its negative association with several unfavourable analysts’ forecast and recommendation metrics. Although it’s in line with the predictions of agency theory, it appears that this relation is primarily driven by firms that are subjected to stronger external monitoring mechanisms proxied by higher corporate governance scores, higher susceptibility to takeovers, and higher firm-level political risk. Together, our findings suggest that analysts are a proxy for unobserved factors that affect CEOs’ ACOMP and are effective in disciplining CEOs by way of reduced ACOMP