Two essays on analyst behavior and audit pricing

Abstract

Essay I Product Similarity and Sell-Side Analysts Although it is well known that analysts are industry specialists, little direct evidence exists to explain this phenomenon. Since product similarity is a prominent feature of firms in related industries, and Chamberlin (1933) and Hotelling (1929) famously show that product differentiation is fundamental to industrial organization, product similarity may be a key driver of analysts’ specialization. We find that analysts add a firm to (drop a firm from) their portfolios if its product is more (less) similar to the other firms in their portfolios, and analysts issue more accurate forecasts than other analysts covering the same firm when the firm is more similar to the other firms in their portfolios. Also, analysts whose portfolios comprise firms with greater product similarity experience better career outcomes. Further, these beneficial effects attenuate as product similarity increases. Our study provides a direct explanation for the industry specialization of analysts, and, to the best of our knowledge, is the first to investigate the portfolio management decisions of analysts. Essay II The Pricing Strategies of Industry Specialist Auditors: The Role of Product Similarity We examine how industry specialist auditors price their clients differently within their portfolio by analyzing the effects of product similarity on audit pricing in the United States. We find that, at the firm level, companies with higher product similarity are generally associated with lower audit fee and shorter reporting lag. At the industry level, industries with higher level product similarity are associated with higher market concentration and market dominancy, while homogeneous industries in product are associated with higher market concentration but lower industry dominancy. Industry specialists who benefit from both cost saving and market position building thus provide larger discounts to clients with higher product similarity than non-industry specialists. Our study suggests that auditors use different pricing strategies to manage their portfolios and contributes to our understating of audit pricing.

Date of Award	2014
Original language	English
Awarding Institution	The Hong Kong University of Science and Technology