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Analyst Following, Information Asymmetry and Cost of Capital: A Discussion of Bowen, Chen and Cheng (2008)

Bowen, Chen and Cheng (2008) document a negative association between analyst following and the discount at issuance of seasoned equity offerings which, they argue, provides evidence of a direct link between analyst following, information asymmetry and cost of capital. While the empirical setting is novel and the analysis is careful, I argue that the causal links are less clear. In particular, I consider whether the evidence demonstrates that (a) analyst following causes a reduction in information asymmetry, (b) a reduction in information asymmetry causes the lower discount at equity issuance, and (c) the lower discount at equity issuance implies a lower cost of capital. In particular, prior literature suggests that analysts are attracted to firms with less information asymmetry, potentially reversing the causality between analyst following and information asymmetry. Further, the discount at issuance behaves much like price pressure, suggesting that analyst following may reflect investor attention rather than a reduction of information asymmetry. Finally, the discount is only one component of the cost of capital. To the extent that analyst following reduces the previously-documented mispricing at equity issuance it may actually increase overall cost of capital.