Essays on Peer Information Environment in Corporate Finance

This thesis explores the general research problems on peer information environment in corporate finance in the U.S. equity market. Surrounding this general theme, this thesis aims to focus on three corporate aspects: the influence of the peer information environment, specifically the external information about peer firms conveyed by information intermediaries, on focal firms’ (i) stock price crash risk; (ii) investment efficiency; and (iii) innovation activities, in three empirical chapters. This thesis is structured into six chapters: Chapter One provides an introduction and outlines the research questions. Chapter Two reviews the relevant literature. Chapters Three, Four and Five separately present the three core empirical studies, and Chapter Six concludes. The peer information environment plays a vital role in conveying incremental information to managers and shareholders (Leary & Roberts, 2014). For managers, it enriches the information available for corporate decisions. For shareholders, they can leverage peer information to discipline managerial behaviour and reduce principle-agent issues. One related managerial behaviour is the tendency of bad news hoarding, which could result in extreme adverse outcomes in the stock market, known as price crashes (Jin & Myers 2006). Motivated by the theory of peer learning motives and bad news hoarding theory of crash risk, the first research question, presented in Chapter Three, investigates the influences of peer information environment on a firm’s stock price crash risk. Using peer analyst coverage as a proxy, I find that the peer information environment is negatively associated with the focal firm’s stock price crash risk. This finding is consistent with the view that peer information plays a vital role in conveying information to managers and shareholders, reducing information asymmetry. The finding also supports the view that peer information serves as a monitoring mechanism in reducing principle-agent issues. Moreover, I find that larger peer firms and more relevant peer firms tend to strengthen the relationship between the peer information and focal firms’ stock price crash risk. Peer information also enhances the relationship between the focal firm’s information environment and its crash risk. In the subject matter of how firms efficiently allocate scarce funds on assets, the second research question explores the link between peer information environment and firm investment efficiency. Roychowdhury, Shroff and Verdi (2019) suggest that peer managers could learn from peer disclosures to complement their own internal information in determining the optimal investment decision. New information about peer firms analysed and conveyed by peers’ analysts allows peer managers to compare their own information environment with that of peers, enrich managerial information set, which results in optimal investment decisions. Results indicate a positive impact of peer information environment, proxied by peer analyst coverage, on the efficiency of firms’ investment. The effect is more salient when a focal firm has a poorer information environment, weaker corporate governance, and a higher volume of informed trading. These findings align with the view that peer information plays a dual role, contributing to both information accumulation and monitoring function, which in turn helps reduce information asymmetry between shareholders and managers. Additional tests also reveal that the positive association is more pronounced in firms with higher similarity scores with their peers, indicating that more relevant peers represent more effective information dissemination in influencing the focal firms. However, it is important to highlight that the positive impact of peer information is temporary, diminishing within a two-year timeframe. Research and development (R&D) is a costly, time-intensive aspect of corporate innovation, yet essential to a country’s economic growth (Schumpeter 1911). Innovation is inherently high risk in nature, primarily due to information asymmetry and uncertainties, and, given the significant capital expenditure involved, motivating managers to innovate can be challenging (Brown, Martinsson & Petersen 2013). If the availability of peer information could lead to information accumulation, this would reduce information uncertainties surrounding innovative projects, ultimately encouraging firms to innovate. As such, the third research question attempts to examine the impact of the peer information environment on corporate innovation. Using two natural experiments, broker house closures and mergers, as the sources of exogenous shocks to analyst coverage reduction experienced by the peer firms, this study finds that an exogenous drop in analyst covering peer firms contributes to a lower level of innovation output. This finding aligns with the information accumulation effect of financial analysts, highlighting their role in reducing information asymmetry and uncertainty in facilitating innovation. Cross-sectional analyses further reveal that the positive association is more pronounced in focal firms with richer information environments, more robust corporate governance, fewer financial constraints, and higher product similarity with their peers. In all three empirical studies, peers of a focal firm are identified using the Text-Based Network Industry Classification (TNIC) developed by Hoberg and Phillips (2016, 2010). This classification system uses textual analysis of business descriptions to dynamically identify peers based on product similarity, which allows for a flexible, time-sensitive approach to categorizing firms. This peer classification that provides time-varying pairs of peers also allows for identification strategy in the attempts to alleviate endogeneity concerns. This thesis not only contributes to the literature of peer effect, but also adds to a growing body of research in stock price crash risk, investment efficiency and corporate innovation, particularly in examining how these corporate issues can be influenced by such an additional peer-driven factor. This thesis also raises several practical implications. To the investors, knowing that managers base their decisions on peers, they must consider the information of peers of the company they invest in when making individual investment decisions. To the managers, not only do they need to be cognizant of the impact of peer information on firm value due to their information disclosure and corporate decisions, but they must also understand how the share market participants would react to their release of information and decisions and that of their peers. To the regulators, the importance of peer information should be factored into their assessment of the disclosure adequacy of companies. Changes in corporate decisions and policies characterised by peer environment can also contribute to better transparency in financial reporting and decision-making due to peer pressure, ultimately resulting in market efficiency.<p></p>