Does Greater Public Scrutiny Hurt a Firm’s Performance?

Benjamin Bennett is Assistant Professor at the Tulane University A.B. Freeman School of Business; René M. Stulz is the Everett D. Reese Chair of Banking and Monetary Economics at the Fisher College of Business at The Ohio State University; and Zexi Wang is an Associate Professor at the Lancaster University School of Management. This post is based on their recent paper.

CEOs are often concerned about the public scrutiny that comes with leading a public firm. Founders want their firm to stay private to avoid that scrutiny. Public scrutiny can be valuable, however, as it can lead to more monitoring of firms, which may improve performance. At the same time, greater attention can have adverse effects. For instance, it can distract managers, preventing them from spending their time on issues internal to the firm, and can make it difficult for firms to stand out and implement policies that may be unpopular with the public. Consequently, while public attention may have a positive side, it may also have a dark side. In this paper, we investigate whether public scrutiny benefits firm performance. We find evidence that an increase in public scrutiny has an adverse effect on firm performance.

Public attention varies among public firms. Some firms consistently receive more attention because they are more prominent or salient. For firms subject to more scrutiny, mistakes may have larger consequences as they are noticed more. Policy differences with comparable firms will be better known and raise more questions. Firm actions may be more likely to be noticed and criticized by politicians. The firm may become more exposed to legal and regulatory actions. As a result, greater attention could affect performance negatively and may force firms to take actions they would not take absent the greater attention. For instance, greater public attention might cause management to choose policies more similar to those of peers even if it would not do so in the absence of greater public scrutiny. Management might do so because it does not want its policies to stand out, because sectors of the public push for such policies, or because these policies are optimal given the heightened attention. We therefore investigate whether one channel through which greater public attention affects performance is in causing firms with greater attention to have policies more similar to their peers.

The challenge in examining whether an increase in public attention causes a firm’s performance to fall and its corporate policies to become more similar to those of peers with a similar level of attention is that an increase in public attention can be caused by firm developments that themselves can affect performance. Such an outcome could lead the researcher to incorrectly conclude that greater scrutiny affects performance when some other development is responsible for the change in performance. For instance, a young public firm may receive a lot of attention because it is growing quickly. To study the effect of an increase in scrutiny, the researcher needs to find an increase that is caused by an event that itself has no impact on performance except possibly through its impact on attention. We use inclusion in the S&P 500 index as such an event. When a firm’s public attention increases following S&P 500 inclusion, there is no reason to suspect that it does so for reasons other than the firm having been included in the index. It seems implausible that the S&P index committee would pick firms to include in the index because it believes that these firms will receive greater attention in the future for reasons other than being included in the index or that it would be able to identify such firms.

We show first that firms included in the index experience a large increase in public attention. As far as we know, we are the first to show that inclusion in the S&P 500 has a broad-based, permanent, and substantial impact on public attention. We show that media coverage, analyst coverage, Google searches, SEC downloads, SEC comment letters, lawsuits, and shareholder proposals all increase following inclusion. We find that the increase in attention does not occur for firms that are comparable to the included firms before inclusion but that are not included in the index.

After having shown that a firm added to the index experiences an increase in public attention, we investigate whether the performance of the firm changes after inclusion and whether this change in performance is related to the change in attention. Specifically, we study the impact of increased public scrutiny on two measures of performance: return on assets (ROA) and cumulative abnormal returns (CAR). We find that these measures fall following inclusion compared to similar firms that are not included in the index, so that firm performance falls following index inclusion. We further show that there is a negative relation between the extent of the change in attention and the performance measures for included firms. In other words, the performance decreases more for firms that experience a greater increase in attention when they join the S&P 500 index.

Why would performance drop following an increase in attention? A possibility is management distraction since, generally, management will have to spend more time on less productive tasks involving interactions with sectors of the public. In addition, management and boards typically try to avoid controversy. When we decompose the change in ROA, we find that the increase in attention is followed by higher costs and lower margins. These changes are consistent with management being more reluctant to face controversy because of aggressive actions to reduce costs. We find directly that idiosyncratic volatility falls following inclusion, which is consistent with management becoming more conservative. Another way for a firm to reduce controversy is to adopt investment and financial policies that are more suited to the higher level of public scrutiny. Such policies are likely to be more similar to the policies of their industry peers that have a similar level of attention. We show that included firms pay more attention to the SEC filings of their index industry peers after inclusion and this effect is large.

To mitigate the impact of the increase in attention, we would expect firms that experience an increase in attention to choose investment and payout policies that are more similar to their peers who draw a similar amount of attention. We find that, in general, S&P 500 firms invest less than other firms controlling for relevant characteristics. We therefore expect firms added to the index to decrease investment. We show that this is the case. The decrease in investment is driven by a decrease in spending on acquisitions rather than spending on capital expenditures. Such a result is consistent with firms receiving more attention from regulators, so that they may get more pushback for acquisitions. Further, we expect the investment of included firms to comove more with their S&P 500 peers. We find strong evidence supportive of this prediction. Specifically, the investment of included firms after inclusion increases by $0.74 for every dollar of increase in investment for S&P 500 peers. Before inclusion, investment increases only by $0.29.

We also study whether firms added to the index make their payout policies more similar to those of firms in the index. In general, S&P 500 firms repurchase more than other firms. The difference is substantial as it corresponds to 1.9% of assets per year. We show that when a firm is added to the index, repurchases increase by 1.6% of assets per year. We further show that the repurchases of an added firm comove more with the repurchases of index industry peers after inclusion. The effect is large. Before inclusion, the included firm’s repurchases increase by $0.22 for each dollar of increase in index peer firms’ repurchases. After inclusion, a one-dollar increase in repurchases of index peers is accompanied by a $0.76 increase in repurchases for the included firm.

One might be concerned that the changes in corporate policies we observe are caused by changes in ownership resulting from index inclusion. We show that this is not the case. Specifically, the increase in passive investor holdings resulting from the firm’s index inclusion does not explain these changes in corporate policies.

The link to the paper on SSRN is here.

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