Does It Pay to be Socially Connected with Wall Street? Evidence from Cost of Equity

Abstract

We investigate whether social connections of a firm’s executives and directors with brokerage houses that follow the firm will affect the firm’s cost of equity. We find that a firm’s cost of equity significantly decreases with its social connectedness with brokerages, and that the effect is more pronounced for firms with more soft information, opaque information environment, tight financial constraints, or weak corporate governance. We use two types of quasi-natural experiments to address endogeneity concerns: 1) exogenous brokerage exit and 2) CEO turnover with internal CEO replacement. We find that an exogenous reduction in firm-brokerage social connections leads to an economically large increase in the firm’s cost of equity, indicating that the effect of social connections in reducing cost of equity is likely causal. Our results are robust to using alternative measures of cost of equity. Further, consistent with the evidence on cost of equity, we find that firm-brokerage social connections improve the firm’s equity valuation.