When paying companies talk, do investors listen?

Abstract

I study the effect of paid-for research coverage on investors' reactions to corporate financial disclosures. Despite prior research indicating that the informational content of paid-for research is valuable, practitioners have constantly cast doubt on the practical usefulness of such research due to the potential for conflict of interest and lack of independence. Investors may consider financial information less credible if the company uses paid-for research services because paid analysts are ineffective as monitors. Therefore, investors respond less intensively to earnings announcements. Using data for U.S. paying companies for the period between 2000 and 2022 and investors' abnormal trading volume around quarterly earnings announcements as a proxy for their reaction to corporate disclosures, I find that investors exhibit a weaker reaction to the earnings announcements of firms after those firms begin using the services of paid-for research firms. The results support the proposition that investors’ reactions to the disclosures of companies become less vigorous after companies engage with paid-for research, possibly due to the lower perceived credibility of the financial information in the eyes of investors. The cross-sectional tests reveal that the negative effect is more substantial for paying companies with paid-for research contracts with less credible research firms or using low-quality auditors for financial reporting. In other words, high-quality research firms or auditors moderate the negative effect of paid-for research engagement on the perceived credibility of corporate information in the eyes of investors. Thus, investors’ reactions to earnings announcements do not decline as much as in other cases. The robustness tests show that paying companies in less uncertain businesses experience larger declines in investor sensitivity to earnings disclosure than those in highly uncertain businesses. I also find that the negative effect is more pronounced for companies with high predisclosure levels. These results provide evidence that the decline in investors’ sensitivity to earnings announcements after paid-for research engagement is not due to decreased information asymmetry. Another test suggests that the decline in investors’ reactions to earnings announcements is not due to the initiation of the coverage of neglected stocks. The additional analyses indicate that the negative effect of paid-for research subscriptions on investors’ reactions to corporate disclosures is more substantial in the first year after the start of the subscription, and the effect disappears in the following year. The effect is also more significant at paying companies with low ex ante interest from investors. In a nutshell, engagement with paid-for research by analysts causes investors to react less vigorously to earnings news because the perceived credibility of financial reporting declines after paid-for research engagement.