Word-of-mouth communication,noise-driven volatility,and public disclosure

This paper examines how a firm adjusts its disclosure quality in response to technological innovations that improve investors' private information. We show that more precise private information can endogenously amplify supply shocks and, hence, increase noise-driven (or non-fundamental) price volatility. We study how the firm reacts to such changes and derive a necessary and sufficient condition under which the firm improves its disclosure quality when investors are informed with better private signals. We then apply our model to study investors' private word-of-mouth communication. Our analysis highlights a “dark side” of word-of-mouth communication and a call for better public disclosure even if private communication is assumed to be unbiased and truthful. We provide empirical predictions regarding how price volatility, market depth, and firms’ disclosure qualities would change as technological innovations, such as social media, facilitate information sharing among investors.     

MARKET EXPECTATIONS AND THE VALUATION EFFECTS OF EQUITY ISSUANCE

We examine how the wealth effects of equity offers are influenced by investors' expectation of the equity type (public or private) to be issued. Firms deviating to the public market may be issuing when information asymmetry or agency costs are high, and their wealth effects are more negative than for firms that are anticipated to issue equity publicly. Firms deviating to the private market, however, may signal firm undervaluation or monitoring benefits and experience more positive wealth effects than firms that are expected to issue equity privately. For the private issues, public market accessibility appears to influence the wealth effects.     

How does institutional investors' information acquisition inhibit share pledging? Evidence from China

This study investigates whether and how institutional investors' information acquisition affects controlling shareholder's share pledging. Taking a unique data of institutional investors' corporate site visits in China, we find that institutional investors' corporate site visits significantly inhibit controlling shareholder's share pledging. This effect is robust to a series of robustness checks, including controlling for endogeneity concerns, propensity score matching method, alternative model specifications, and alternative measures of the independent variable. We then provide evidence that the negative relation between institutional investors' corporate site visits and controlling shareholder's share pledging is more pronounced for listed firms with less efficient information environment and weaker corporate governance. Further analysis indicates that the negative relation is also more pronounced when controlling shareholders are under higher margin call pressure and when the visiting institutional investors consist of more fund companies. Overall, our study is the first to provide direct evidence of the governance mechanism of financial intermediaries on shareholders' pledging decisions.     

Pro forma accounting disclosures: The effect of reconciliations and financial reporting knowledge on nonprofessional investors' judgments

Regulation G requires companies that report non-GAAP or “pro forma” earnings provide a reconciliation. While nonprofessional investors are a large, heterogeneous population with varying degrees of financial reporting knowledge, previous research treats them as a homogenous group. The study examines how differences in financial reporting knowledge and information viewing behavior affect the influence of reconciled pro forma earnings disclosures on nonprofessional investors' judgments. Lower-knowledge investors appear to incorporate information on differences between GAAP and pro forma earnings in their judgments as long as they view this information in the reconciliation. However, higher-knowledge investors appear to consistently incorporate information on differences between GAAP and pro forma earnings in their judgments regardless of the relative amount of time they spend viewing the reconciliation relative to other disclosures. Our results suggest that knowledge differences influence how nonprofessional investors acquire and use information on differences between GAAP and pro forma earnings.     

Investors' time preferences and takeover performance

We investigate investors' time preferences and takeover outcomes in a cross-disciplinary international study. We use a cultural measure on long-term orientation (LTO) to capture investors' time preferences. Additionally, we study how investor protection and the nature of the deal (cross-border vs domestic) in connection with investors' time preferences come into play in explaining long-term takeover performance. Evaluating data on 38,153 M&A deals from 54 countries, over the period from 2000 to 2015, we offer empirical evidence that investors' future orientation significantly improves post-M&A performance, while short-term oriented behavior deteriorates takeover performance. Our findings further suggest that the positive impact of investors' future orientation on takeover performance is more pronounced in countries with strong investor protection. Moreover, the impact of investors' time preferences is stronger for domestic deals where the confounding impact of cultural differences is almost non-existent.     

Dynamic financial contracting with persistent private information

We study a dynamic agency model where the agent privately observes the firm's cash flows that are subject to persistent shocks. We characterize the policy dynamics and implement the optimal contract by financial securities. Because bad performance distorts investors' beliefs downward, the agent has less incentive to misrepresent information. The agent's compensation is less than what he can divert and is convex in performance. As private information becomes more persistent, (i) the agent is compensated more by stock options; (ii) firm credit limits vary more with history, dropping after bad performance; (iii) the firm is financially constrained for longer time.     

Effect of corporate disclosure and press media on market liquidity: Evidence from Japan

News on corporate information can enhance clarity or add to confusion for market participants, especially investors. We explore how two diverse types of information dissemination —corporate disclosure and media coverage—influence stock market liquidity by mediating information asymmetries. We conclude that the two information inflows have notable and distinct impacts on liquidity. Our chief finding suggests that information from corporate disclosures induces a wider bid-ask spread, consistent with increased information asymmetries among investors. In contrast, we find that press media coverage—both good and bad news—improves liquidity. This indicates that mass media is a critical channel that provides investors with news to mitigate information uncertainty. Further, this media effect is partly driven by original journalism coverage and assistance for investors' information assimilation. Finally, in the case of stocks in which retail investors' participation is greater, the liquidity-improving effect of mass media is more prominent.     

Leverage Is a Double-Edged Sword

We use proprietary data on intraday transactions at a futures brokerage to analyze how implied leverage influences trading performance. Across all investors, leverage is negatively related to performance, due partly to increased trading costs and partly to forced liquidations resulting from margin calls. Defining skill out-of-sample, we find that relative performance differentials across unskilled and skilled investors persist. Unskilled investors' leverage amplifies losses from lottery preferences and the disposition effect. Leverage stimulates liquidity provision by skilled investors, and enhances returns. Although regulatory increases in required margins decrease skilled investors' returns, they enhance overall returns, and attenuate return volatility.     

Which Investors Fear Expropriation? Evidence from Investors' Portfolio Choices

Using a data set that provides unprecedented detail on investors' stockholdings, we analyze whether investors take the quality of corporate governance into account when selecting stocks. We find that all categories of investors (domestic and foreign, institutional and small individual) who generally enjoy only security benefits are reluctant to invest in companies with weak corporate governance. In contrast, individuals connected with company insiders are more likely to invest in weak corporate governance companies. These findings suggest that it is important to distinguish between investors who enjoy private benefits or access private information, and investors who enjoy only security benefits.     

Corporate investment and stock market valuation

We study the driving forces behind the positive association observed between corporate investment and stock market valuation, and how they interact with managerial equity incentives and informativeness of investment. We build a dynamic model where managers use investment choices to influence investors' opinions about firms' future prospects and increase the market valuation. The incentives to manipulate the valuation processes increase with managerial equity incentives and informativeness of investment. Our empirical findings support the model's predictions that the tendency of using investment to boost market valuation is stronger when managerial stock ownership is high or when earnings quality is low (i.e., there is strong reliance on investment for information).     

Accounting information,disclosure, and expected utility: Do investors really abhor uncertainty?

Investors are said to “abhor uncertainty,” but if there were no uncertainty they could earn only the risk‐free rate. A fundamental result in the analytical accounting literature shows that investors buying into a CARA‐normal CAPM market pay lower asset prices, gain higher ex‐ante expected returns, and obtain higher expected utility, when the market payoff has higher variance. New investors obtain similar “welfare” gains from risk under a log/power utility CAPM. These results do not imply that investors “abhor information.” To realize investors' ex‐ante expectations, the subjective probability distributions representing market expectations must be accurate. Greater payoff risk can add to investors' expected utility, but higher ex‐post(realized) utility comes from better information and more accurate ex‐ante expectations. An important implication for accounting is that greater disclosure can have the simultaneous effects of (i) exposing more fully or perceptibly firms' payoff uncertainty, thereby increasing new investors' expected utility, and (ii) improving market estimates of firms' payoff parameters (means, variances, covariances), thereby giving investors a better chance of realizing their expectations. Paradoxically, better information can be valuable to new investors by exposing more fully and more accurately the risk in firms' business operations and results–new investors maximizing expected utility want both more risk and better information.     

Insightful Insiders? Insider Trading and Stock Return around Debt Covenant Violation Disclosures

This study asks whether insider trading associates with an information advantage around first‐time debt covenant violation disclosures in SEC filings, which potentially results from early access to information about the debt covenant violation disclosure. We document two results. First, we find net insider selling up to 12 months before a debt covenant violation disclosure, which precedes investors' negative returns before disclosure; and net insider buying up to 12 months after disclosure, which precedes investors' positive returns after disclosure. Second, we show that net insider trading one to two months before and after the violation disclosure associates predictably with investors' short‐term reaction to the covenant violation announcement.     

FOREIGN INVESTOR PARTICIPATION IN PRIVATIZATIONS: DOES THE INSTITUTIONAL ENVIRONMENT MATTER?

We examine the determinants of foreign investors' participation in the privatization process of developing countries. First, we estimate the probability that foreign investors target privatized firms in a given country. We show that a favorable legal environment where investor protection is higher enhances foreign investors' participation. Foreigners also prefer large, strategic firms from high‐growth economies and socially stable countries with low political risk. Second, we restrict our analysis to privatized firms that foreign investors actually choose and show that the stakes foreigners hold are larger if the firms are privatized by private sales as opposed to public offerings.     

A Theory of Noise Trading in Securities Markets

In a recent article, Black 1 introduces a type of trading that he terms noise trading. He asserts that noise trading, which he defines as trading on noise as if it were information, must be a significant factor in securities markets. However, he does not provide an explanation of why any investors would rationally want to engage in noise trading. The goal of this paper is to provide such an explanation for one type of investor, managers of investment funds. As shown here, the incentive for a manager to engage in noise trading arises because of the positive signal that the level of the manager's trading provides about his or her ability to collect private information concerning current and potential investments. If the manager's compensation is directly related to investors' perceptions of his or her ability, the manager will then trade more frequently than is justified on the basis of his or her private information. In addition to providing this explanation for noise trading, the results of this analysis may also be useful for further empirical exploration of the relation between investment fund portfolio turnover and subsequent performance.     

Top investment banks,confirmation Bias,and the market pricing of forecast revisions

We investigate the impact of top investment banks (hereafter top IBs) on the pricing of forecast revisions through the investors' attention channel by examining the distraction effect and confirmation bias theories. The distraction effect theory predicts that investors' attention shifts to consensus revisions that align with revisions from top IBs, resulting in inattention to other revisions. This theory implies that top IBs primarily benefit investors by directing them to high-quality revisions. In contrast, the confirmation bias theory predicts that top IBs magnify market reaction to forecast revisions and benefit investors by partially offsetting investors' initial underreaction to revisions. Our findings indicate the presence of confirmation bias. We further examine the potential effects of the information content of revisions, analyst agreement, news sentiment, and information uncertainty to test the robustness of our results. Our findings suggest that top IBs ultimately contribute to the price discovery process by attracting investors' attention and this effect does not channel through the quality of consensus revisions.     

Fund managers' herding and the sensitivity of fund flows to past performance

This study provides a new explanation for the weak sensitivity of investors' flows to poor fund performance based on fund managers' incentives to herd from career concerns. We show that a manager's decision to trade with (against) the herd decreases (increases) significantly investors' willingness to redeem capital from underperforming funds. We argue that this differential investor reaction to poor performance conditional on herding explains the lower termination risk identified among herding managers. We also find that financial intermediaries do not mitigate this sub-optimal investors' response. Our findings support the view that underperforming funds can retain larger payoffs if they herd.     

Firm Value and the Choice of Offering Method in Initial Public Offerings

A firm raising capital in an initial public offering faces the problems of choosing between a firm-commitment and a best-efforts offering and of how to convey information about its value to potential investors. The offering method chosen affects both the firm's cost of obtaining capital and investors' perceptions about firm value. A partially pooling, partially separating equilibrium is found where high-valued firms have information about their values revealed in a firm-commitment offering, while low-valued firms use best-efforts offerings and are unable to distinguish themselves from other firms.     

In name only: Information spillovers among Chinese firms with similar stock names during earnings announcements

We examine whether investors' attention on salient firm characteristics affects information spillovers during corporate earnings announcements. For market participants in China, the stock name is a salient feature of listed companies. We find that the market reaction of non-announcing firms to earnings reports of announcing firms is greater across firms with similar stock names. The incremental information spillovers among similarly named stocks are stronger for larger announcing firms and on days with fewer earnings announcements. The incremental information spillovers between similarly named stocks do not fully reverse in the post-announcement period, consistent with persistent investor behavior predicted by the salience theory. There are also significant return comovements among similarly named stocks. Our findings suggest that investors with limited attention are likely to focus on salient stock names and overestimate the economic connections between similarly name stocks. Our study extends the behavioral finance literature by showing how investors' attention on salient firm features can bias their reaction to unrelated peer disclosures.     

Is Investor Attention for Sale? The Role of Advertising in Financial Markets

Prior research documents capital market benefits of increased investor attention to accounting disclosures and media coverage; however, little is known about how investors and markets respond to attention‐grabbing events that reveal little nonpublic information. We use daily firm advertising data to test how advertisements, which are designed to attract consumers' attention, influence investors' attention and financial markets (i.e., spillover effects). Exploiting the fact that firms often advertise at weekly intervals, we use an instrumental variables approach to provide evidence that print ads, especially in business publications, trigger temporary spikes in investor attention. We further find that trading volume and quoted dollar depths increase on days with ads in a business publication. We contribute to research on how management choices influence firms' information environments, determinants and consequences of investor attention, and consequences of advertising for financial markets.