ESSAYS ON INFORMATION PRODUCTION AND DIFFUSION IN FINANCIAL MARKETS
Heston, Steven L
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This dissertation contains two essays that study the information produced by equity analysts and how the diffusion, or lack thereof, of this information affects financial markets. In the first essay, "Does the Precision of Equity Analysts Matter? Evidence from the Textual Content of Analysts’ Reports", I propose that analyst’s precision and opinion jointly explain a range of market outcomes, including returns, volume, and volatility, of the publication of an analyst report. I construct a novel measure of precision based on textual analysis of equity analysts’ reports. I find that for pessimistic reports, higher precision is associated with a significantly larger negative price reaction. Moreover, the higher precision is associated with higher abnormal turnover, higher volatility, and lower change in uncertainty. However, precision is not significantly or only weakly correlated with market reaction for optimistic reports. I argue that this dichotomy is a result of the well-known optimism bias of equity analysts and of a tendency of analysts to inflate the precision of more optimistic reports. I also show that the relation between precision and price reaction varies depending on the information environment and on textual characteristics of the analyst report. In the second essay, "Information Asymmetry, Agency Conflicts, and the Cost of Capital", I study the causal relation between information asymmetry and the cost of capital employing the exogenous increase in information asymmetry caused by the loss of equity analysts due to brokers’ closures or mergers, In particular, I focus on understanding how information asymmetry differentially affects the cost of debt and the cost of equity and how managerial and debt agency conflicts affect this relation. I find that an increase in information asymmetry results in higher cost of equity (debt) when the shock is greater and when incentives to engage in debt-equity wealth transfers are low (high). These results suggest that for some firms, differently from what usually assumed, the cost of debt can actually be more sensitive than the cost of equity. I argue that these findings are consistent with the hypothesis that an information asymmetry increase is not necessarily costly for shareholders, since it can facilitate debt-equity wealth transfers that can reduce equity risk.