There is growing literature examining the economic consequences of social ties between different market participants in the capital market. Security analysts and auditors are both important market participants and have a significant influence on the information environment of the companies. The literature on the effect of social ties between these two participates is lacking. This thesis investigates the interaction between security analysts and auditors from the perspective of social ties. Analysts need to collect various company information. Compared with analysts, auditors have greater access to private information about the company. Although analysts and auditors do not have direct information channels, the school ties between analysts and auditors may facilitate the information transfer between the two parties. The purpose of this study is to investigate the likelihood of this information transfer and its impact on analyst behaviors. Specifically, this study firstly investigates whether the school ties affect the coverage decisions of analysts. Then this study examines the influence of the school ties on analyst forecasting performance. Furthermore, this study investigates whether the connected analysts influence the information environment of those unconnected analysts.

Based on a sample of analyst earnings forecasts issued to Chinese A-share listed companies from 2008 to 2016, I find that when analysts enter a new industry, they are more likely to initiate coverage on companies if they have school ties with those companies’ auditors. I also find that auditors are less likely to drop the coverage on companies if they have school ties with their auditors. Moreover, the analyst-auditor school ties improve the accuracy of analysts’ forecasts and mitigate the optimism of analysts’ forecasts. The positive effect of the school ties on the quality of analyst earnings forecasts is more pronounced when analysts face more challenges to predict the companies’ earnings. Finally, I find that the existence of connected analysts improves the quality of forecasts issued by unconnected analysts, indicating that the information advantage that connected analysts obtain from the school ties with auditors is beneficial to analysts’ information environment through spillover effect.

This thesis contributes to the literature in several ways. First, this study finds that signing auditors serve as an important information source for analysts, complementing the existing studies that suggest management as the primary channel from which analyst obtains private information. The findings in this study indicate that, although the duty of confidentiality of auditors may seem to prevent information flow from auditors to analysts, the informal alumni relationship between individuals can facilitate the information transfer. The findings identify a new determinant of analyst behaviors and enrich the research about how social ties affect the information flow in the capital market. Second, this study examines the effect of the school ties with auditors on analyst coverage decisions. Most prior studies examine how companies’ characteristics affect analyst following. There is little evidence from the perspective of individual analysts. The evidence in this study is helpful to add a new dimension to understand the decision process of analysts’ coverage decision. Third, this study provides evidence that supports the spillover effect from informed analysts to uninformed analysts, extending the existing literature on the externality of social ties. Finally, this study extends the research about interactions between different parties in the information environment. Most current studies investigate the substitute relationship or complement relationship between various parties from the formal institutional arrangements. This study suggests that informal relationships can also affect information flow hence the information environment.