The Economist recently summarized an interesting a study co-authored by James Westphal (Michigan) and Melissa Graebner (Texas) that appeared in the Academy of Management Journal (for the Economist summary click How Firms Fool Equity Analysts, for information about the full research article visit the AMJ website). According to the Economist:

How do you pump up the value of your company in these difficult times? One tried and tested way is to hoodwink equity analysts, according to a new study of 1,300 corporate bosses, board directors and analysts.

The authors found that chief executives commonly respond to negative appraisals from Wall Street by managing appearances, rather than making changes that actually improve corporate governance: boards are made more formally independent, but without actually increasing their ability to control management. This is typically done by hiring directors who, although they may have no business ties to the company, are socially close to its top brass.

The tactic pays off with appreciably higher ratings. At firms that make a strenuous effort to persuade analysts that such board changes have boosted independence, and thus made management more accountable, the likelihood of a subsequent stock upgrade rises by 36%, the study concluded. The chance of a downgrade, meanwhile, falls by 45%.

In Governance modules of Corporate Strategy, it is important to stress the difference between inside/outside directors and independent/non-independent directors. The take-away: OUTSIDE ≠ INDEPENDENT. They are not mutually inclusive. Unfortunately in practice, it seems that analysts don’t treat them accordingly.

Be Sociable, Share!

• 

This entry was posted on Thursday, February 18th, 2010 at 5:00 am and is filed under Corporate Strategy. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.