The Determinants and Effects of Effective Investor Relations (IR)

Abstract

This research concerns relationships between effective IR and stock pricing and stock liquidity and analyst coverage. This thesis develops the IR literature by using an original and focused measure of IR performance, numbers of firms' nominations for the Investor Relations Magazine IR awards 1999-2002, and by testing for any direct relationships between firms' number of award nominations and stock price, liquidity and analyst coverage over periods surrounding these awards and by exploring a wider range of firm characteristics compared to existing research. It is motivated by a seminal paper claiming that effective IR indirectly reduces the cost of equity capital, based a chain of existing research (Brennan and Tamaronski, 2000). Firstly, effective IR increases analyst coverage by reducing analysts' information-search costs, (Bhushan, 1989b, Lang and Lundholm, 1996, Francis, Hannah and Philbrick, 1997, Holland 1998b). Higher coverage can directly reduce information asymmetry and trading costs, increasing liquidity and indirectly increasing equity trading volumes (Brennan and Subrahmanyan, 1996). Finally, Amihud, Mendelson and Lauterbach (1997) show a direct inverse relationship between stock liquidity and stock prices, thus completing the putative chain between effective IR and a reduced cost of equity. However, any research showing a direct relationship between effective IR and the cost of capital is limited, with Botosan (1997) only finding a direct negative relationship for a sample of US firms with effective annual reports and low analyst coverage, and more recent research by Botosan and Plumlee (2002) shows no relationship to firms' IR ratings from analysts of the Association of Investment Management and Research (AIMR).

I find, firstly, that prior to the IR awards the smaller-sized firms earn excess equity returns and a positive relationship between the number of firms' IR award nominations and prior analyst coverage. Secondly, I find that subsequent to the IR awards the firms continue to have high levels of analyst coverage, but do not earn excess stock returns. These findings suggest that analysts cover high momentum small-firm stocks and generally follow firms with effective IR, and also contributes to other research on prior factors that appear to influence firms' ratings in subjective firm-surveys, which behavioural finance attributes to the survey respondents' psychological preferences and biases. Finally, I find that effective IR is associated with a subsequent significant increase in stock liquidity and a reduced cost of equity, consistent with information risk and agency theories, which predict that effective IR will reduce risks attached to stocks due to high information asymmetry.