Investor Relations, Liquidity, And Stock Prices

Although the first investor relations department was established by General Electric as long ago as 1952, the role of investor relations (IR) is one that has largely escaped scientific analysis and academic scrutiny. This article attempts to demonstrate the importance of a company's IR activities for its stock price by establishing a clear chain of causation between the following: 1 corporate IR activities and the number of stock analysts who follow the firm; 2 the number of analysts who follow the firm and the liquidity of trading in the firm's shares; 3 the liquidity of the firm's shares and its required rate of return, or cost of capital. The authors begin by presenting evidence that corporate IR activities, in the form of high levels of disclosure and presentations to investment analysts, increase the number of analysts who follow the firm by reducing their cost of acquiring information. Studies have also shown that more effective IR tends to improve the accuracy of analyst forecasts and the degree of agreement among analysts. Second, the authors summarize their own research showing that the number of analysts who follow a firm has a positive effect on the liquidity of the firm's shares. More specifically, their findings can be interpreted as saying that, for the average company, coverage by six additional analysts reduces “market‐impact costs” (using a measure known as Kyle's lambda) by 28%, holding volume constant. And when the indirect effect of increased analyst coverage through expanded volume is taken into account, the reduction in trading costs is estimated to be as high as 85%. The final link in the chain of analysis is the growing evidence (much of it reviewed in the preceding article) that increased liquidity leads to a lower cost of capital and thus higher stock prices. In sum, a firm can reduce its cost of capital and increase its stock price through more effective investor relations activities, which reduce the cost of information to the market and to investment analysts in particular.