Analyst Optimism and Incentives under Market Uncertainty

We examine how analysts’ changing incentives driven by changes in market uncertainty affect their forecast optimism. Analysts issue more optimistically biased earnings forecasts and buy recommendations under high market uncertainty (VIX). The lower reputational costs and larger benefits of optimistic output explain the increased optimistic output: Analysts are less likely to be penalized for inaccuracy and can stimulate more trading activity from optimistically biased output when market uncertainty is high. We find that the likelihood of analysts’ turnover decreases, while the trading volume associated with optimistic output increases, with VIX. No evidence suggests that analysts’ self‐selection affects our findings on optimism and market uncertainty.     

Economic policy uncertainty and analysts’ forecast characteristics

We examine the influence of economic policy uncertainty (EPU) on the characteristics of analysts’ earnings forecasts over a thirty-year period, spanning a wide variety of political and economic conditions. Motivated by both theory and empirical evidence that suggest a decline in the quality of the information environment for firms as EPU increases, we establish that analysts’ forecast errors increase with EPU, as does the degree of forecast dispersion. Increased error and dispersion persist after controlling for several competing sources of economy-wide uncertainty. Cross sectional analysis exploring heterogeneity in forecast quality across both analyst and firm characteristics establishes that forecast error and dispersion increase with EPU across a broad spectrum of firms and levels of analyst expertise. We control for analysts’ experience overall and the years spent covering a particular industry and firm. Five alternative methods for classifying firms as policy sensitive versus policy neutral provide consistent evidence that analyst forecast errors and dispersion increase with EPU, even for firms not deemed to be particularly sensitive to policy.     

Product market competition and cost stickiness

Extant literature on cost stickiness has focused on how firm-specific characteristics affect the asymmetric cost behavior. In this paper, we explore how a firm’s operating environment affects the firm’s cost stickiness. Specifically, we examine the effect of product market competition on cost stickiness since a firm’s investment and cost retention decisions partly depend on how the firm interacts with its rival firms in the product markets. Using two firm-level text-based product market competition measures extracted from management disclosures in firms’ 10-K filings (Li et al. in J Account Res 51(2):399–436, 2013; Hoberg and Phillips in Rev Financ Stud 23(10):3773–3811, 2010; J Polit Econ, 2015), we find strong evidence consistent with cost asymmetry increasing in competition after controlling for known economic determinants of cost stickiness. In additional analyses, we also find that the effect of product market competition on the degree of cost stickiness increases in firms’ financial strength, likely because management in financially stronger firms has more resources for investment expenditures in spite of a sales fall. We also find that cost stickiness is increasing in competition if management is optimistic about future demand, whereas competition is not associated with cost asymmetry if management is pessimistic about future demand. Finally, we find that the relationship between competition and cost stickiness, although statistically insignificant at conventional levels, is more pronounced for single-segment firms relative to multi-segment firms.     

Accounting based valuation: a simultaneous equations model for forecasting earnings to proxy for ‘other information’

This paper develops and tests a simultaneous equations model (SEM) for extending accounting based valuation models used in empirical studies. Rather than using analysts’ forecasts, we derive forecasts of operating income from the SEM to calculate the ‘other information’ variable in the Ohlson (Contemp Account Res 11:661–687, 1995) model. The SEM forecasts are based on observable data contained in the firms’ reporting, like order backlog, and other publicly available information. The SEM produces more accurate out-of-sample forecasts of operating income compared to simple benchmark models particularly in years around economic changes and instability, like the years 2001 and 2009. Integrating the SEM forecast as ‘other information’ in market value regressions significantly increases the explanatory power compared to simpler versions without or with single information proxies for ‘other information’. Finally, we find that the SEM forecast is able to explain a major portion of the information advantage of analysts relevant for explaining market values.     

Equilibrium model with default and dynamic insider information

We consider an equilibrium model à la Kyle–Back for a defaultable claim issued by a given firm. In such a market the insider observes continuously in time the value of the firm, which is unobservable by the market makers. Using the construction in Campi et al. (http://hal.archives-ouvertes.fr/hal-00534273/en/, 2011) of a dynamic three-dimensional Bessel bridge, we provide the equilibrium price and the insider’s optimal strategy. As in Campi and Çetin (Finance Stoch. 11:591–602, 2007), the information released by the insider while trading optimally makes the default time predictable in the market’s view at the equilibrium. We conclude the paper by comparing the insider’s expected profits in the static and dynamic private information case. We also compute explicitly the value of the insider’s information in the special cases of a defaultable stock and a bond.     

Product market power and management’s action to avoid earnings disappointment

We investigate the empirical relationship between a firm’s product market power and its management’s action to use real-activity-based earnings management techniques to avoid earnings disappointment by meeting or beating earnings targets such as analysts’ earnings forecasts, positive earnings, or higher earnings relative to previous years. While there is a general consensus that product market competition in an industry affects management’s operating and financial decisions, and thus is an important intervening factor in a firm’s strategies for many economic situations (Nickell in J Political Econ 104:724–746, 1996; Porter in The competitive advantage of nations. Macmillan, London, 1990), the linkage between product market power, managerial incentives, and financial reporting quality has so far received little academic attention. Our analyses show that while the firms manage both accruals and real activities in varying degrees, the firms having greater product market power with the ability to differentiate their products to earn additional revenue, if necessary, are less inclined to engage in real-activity-based earnings management in certain suspect economic situations compared to the firms with less market power. We, however, do not find any significant relationship between product market power and accrual-based earnings management.     

Political uncertainty and firms' information environment: Evidence from China

How political uncertainty affects the supply of value relevant information about a firm is an important but unresolved question. Using an emerging market setting where political leaders are expected to exert significant influence on economic activities, we examine the effect of political uncertainty caused by turnovers of local government leaders on a firm’s information environment. We find that during periods of political uncertainty, the total amount of idiosyncratic information about a firm that is available to the market is reduced. The adverse effect on information supply is manifest in firms that are more politically dependent and stronger when uncertainty is more severe. Further, we provide evidence suggesting that firms react to political uncertainty by reducing the amount and the quality of information provided to investors. We find that information intermediaries such as financial analysts and the media have a moderating effect on the information environment as they increase the production of information during periods of political uncertainty. However, these intermediaries do not negate the net loss of information.     

Are inter-segment revenues informative about future performance?

This study investigates the degree to which a specific component of segmental disclosure, intersegment transactions, informs future segment-level and firm-level profitability. By using segment data reported under the FAS No. 131 regime, we find a positive association between intersegment revenues and one-year-ahead segment operating profits; this association is weakened by agency costs but not proprietary costs. We also find that the aggregate intersegment revenue reported by a firm is positively associated with future firm-level earnings. However, analysts seem to underreact to information in aggregate intersegment revenue.     

The impact of aggregate uncertainty on herding in analysts' stock recommendations

This study examines whether aggregate uncertainty affects the herding tendency among analysts. The results show that, in addition to market risk and firm-level uncertainty, analysts' tendency to herd increases with aggregate uncertainty. These results are robust with respect to excluding common and earnings information, as well as using different measurements of consensus recommendation, risk and aggregate uncertainty. Herding among analysts is stronger when downgrading a stock. The tendency of herding clearly increases in tandem with aggregate uncertainty. The results are more prevalent for small stocks and inexperienced analysts.     

The roles of past returns and firm fundamentals in driving US stock price movements

This paper provides new empirical evidence that incorporating past stock returns from different time horizons can enhance the ability of firm fundamentals to better explain stock price movements but this benefit dissipates under uncertainty. We apply both OLS and state-space modeling to US firms' stock price movements over the period from 1999 to 2012 to compare the roles of the two main types of information typically used by equity investors. Empirical results reveal the importance of firm fundamentals over longer term horizons for particularly, small-cap stocks with greater information uncertainty. Furthermore, when market uncertainty is high, fundamentals unambiguously dominate in driving stock price movements of smaller sized firms indicating that uncertainty at the firm and market level both create attention bias on firm fundamentals.     

CEO bonus compensation: the effects of missing analysts’ revenue forecasts

We investigate the incremental contract relevance of analysts’ revenue forecasts while controlling for earnings forecasts and find CEOs receive smaller bonuses when missing analysts’ annual and quarterly revenue expectations. Our results support the link between the value relevance of the revenue performance measure and the contract relevance of that measure. Further, we find revenue forecasts to be more contract relevant for CEOs of firms with high growth expectations, consistent with Rees and Sivaramakrishnan’s Contemp Acc Res 24(1):259–290, (2007) findings that growth firms receive a larger market penalty for missing revenue targets. Overall, our findings provide empirical support for the conjecture that compensation committees rely on information consistent with that conveyed in analysts’ revenue forecasts when contracting with management.     

Investor relations,information asymmetry and market value

Evidence to date on the market value of investor relations (IR) strategies is limited. We test the market relevance of IR activity directly employing a proprietary database measuring IR quality across all firms listed on NYSE, Amex and NASDAQ. Although, in theory, ‘repackaging’ and communicating existing information should have no market impact, we find that firms with higher quality IR strategies are rewarded with significantly higher valuation multiples. In addition, increase in IR quality is associated with increases in analyst following and liquidity. Overall, our findings are generally stronger for small firms which are more likely to be ‘neglected’. Our evidence is consistent with effective IR successfully raising firm visibility leading to enhanced recognition and reduced information asymmetry in line with Merton (1987 Merton, R., 1987. A simple model of capital market equilibrium with incomplete information. Journal of Finance, 42 (3), 483–510. doi: 10.1111/j.1540-6261.1987.tb04565.x[Crossref], [Web of Science ®] , [Google Scholar]) and thus ‘fairer’ firm valuation as argued by IR professionals.     

Reexamining momentum profits: Underreaction or overreaction to firm-specific information?

We design a new measure and find that the predictability of past returns on future returns increases as stocks respond with delay to firm-specific information. Our results suggest that momentum is caused by both investors’ underreaction and overreaction to information. However, underreaction to information seems to be the primary cause, particularly during the more recent period. Our findings are robust for recent explanations of momentum profits and alternative methods for computing our measure. We also find that stocks respond with delay to firm-specific information, partly due to certain firm characteristics, and partly because they escape investor attention due to their low visibility. Our paper extends and refines Jegadeesh and Titman’s (J Financ 56(2):699–720, 2001) finding that momentum profits are consistent with behavioral models’ predictions regarding investors’ overreaction.     

Contrarian Profits and the Overreaction Hypothesis: the Case of the Athens Stock Exchange

This paper investigates the existence of contrarian profits and their sources for the Athens Stock Exchange (ASE). The empirical analysis decomposes contrarian profits to sources due to common factor reactions, overreaction to firm‐specific information, and profits not related to the previous two terms, as suggested by Jegadeesh and Titman (1995). Furthermore, in view of recent evidence that common stock returns are related to firm characteristics such as size and book‐to‐market equity, the paper decomposes contrarian profits to sources due to factors derived from the Fama and French (1993, 1996) three‐factor model. For the empirical testing, size‐sorted sub‐samples that are rebalanced annually are employed, and in addition, adjustments for thin and infrequent trading are made to the data. The results indicate that serial correlation is present in equity returns and that it leads to significant short‐run contrarian profits that persist even after we adjust for market frictions. Consistent with findings for the US market, contrarian profits decline as one moves from small stocks to large stocks, but only when market frictions are considered. Furthermore, the contribution to contrarian profits due to the overreaction to the firm‐specific component appears larger than the underreaction to the common factors.     

The best of all possible worlds: unraveling target price optimism using analysts’ scenario-based valuations

We document that the relative placement of analysts’ target price within their subjective distribution of scenario-based valuations for the covered firm (i.e., tilt) is informative to investors. When analysts forecast price appreciation, tilt incrementally predicts ex post valuation errors and realized returns; the predictive value of tilt disappears when analysts forecast price declines. In additional analyses, we find that tilt appears to reflect an optimistic bias in target price forecasts as opposed to information about asymmetric state-contingent risk payoffs. Finally, we document that investors can use estimates of implied tilt based on observable firm characteristics to distinguish between investments with equally optimistic target price forecasts, yet lacking scenario-based information.     

Has momentum lost its momentum?

We evaluate the robustness of momentum returns in the US stock market over the period 1965–2012. We find that momentum profits have become insignificant since the late 1990s. Investigations of momentum profits in high and low volatility months address the concerns about unprecedented levels of market volatility in this period rendering momentum strategy unprofitable. Momentum profits remain insignificant in tests designed to control for seasonality, up or down market conditions, firm size and liquidity. Past returns, can no longer explain the cross-sectional variation in stock returns, even following up markets. Investigation of post holding period returns of momentum portfolios and risk adjusted buy and hold returns of stocks in momentum suggests that investors possibly recognize that momentum strategy is profitable and trade in ways that arbitrage away such profits. These findings are partially consistent with Schwert (Handbook of the economics of finance. Elsevier, Amsterdam, 2003) that documents two primary reasons for the disappearance of an anomaly in the behavior of asset prices, first, sample selection bias, and second, uncovering of anomaly by investors who trade in the assets to arbitrage it away. In further analyses we find evidence that suggest two other possible explanations for the declining momentum profits, besides uncovering of the anomaly by investors, that involve decline in the risk premium on a macroeconomic factor, growth rate in industrial production in particular and relative improvement in market efficiency.     

Implications of firm experiential knowledge and sequential FDI on performance of Japanese subsidiaries in Brazil

A foreign firm investing in a culturally different market usually faces a certain level of uncertainty. This study proposes that as a multinational company accumulates experiential knowledge, it develops more capabilities and know-how and consequently reflects on subsidiary performance. Based on a subsidiary level sample of Japanese firms located in Brazil, the empirical findings of this study demonstrate that the accumulation of both international and local experiential knowledge can positively affect subsidiary performance. Moreover, a firm’s sequential foreign direct investment decision in the local market is a key strategy to achieving a higher level of subsidiary profitability in comparison with a first-time investment firm.

Insider Trading in the OTC Market

In this paper, we examine the profitability of insider trading in firms whose securities trade in the OTC/NASDAQ market. Although the evidence suggests timing and forecasting ability on the part of insiders, high transaction costs (especially bid-ask spreads) appear to eliminate the potential for positive abnormal returns from active trading. By implication, outside investors who mimic the trading of insiders are also precluded from earning abnormal profits. In addition, we provide evidence on the determinants of insiders' profits. The data suggest that insiders closer to the firm trade on more valuable information than insiders removed from the firm.     

Prior Information and the Market Reaction to Dividend Changes

We investigate two hypotheses regarding the information content of dividend change announcements. The first is that the importance of information signaled by a dividend change depends on the reliability of earnings forecasts existing before the dividend announcement. The second hypothesis is that the stock price reaction to dividend change announcements is related to earnings forecast error as of the time of the dividend announcement. Our results reveal that dividend increases convey more information for firms in which financial analysts least accurately predict earnings. The results also indicate that dividend increase and decrease announcements provide market participants with information which, on average, allows them to differentiate between firms on the basis of future earnings realizations. These differential information effects are shown to be robust to price, size, dividend yield, and overinvestment effects.     

Firm-level political risk and distance-to-default

This study provides the first empirical evidence of the relationship between firm-level political risk and distance-to-default. Based on our examination of a quarterly dataset of 2727 U.S. firms covering a period from January 2002 to April 2019, we conclude that firm-level political risk is negatively associated with distance-to-default. We document three economic mechanisms through which political risk increases default risk: information asymmetry, organizational capital, and investment growth. The evidence indicates that the association is more pronounced for firms with low analysts’ forecast accuracy, organizational capital, and investment growth. Employing hand-collected data, we also reveal that firms are able to exploit their corporate lobbying to immunize themselves against default risk. Our findings are robust to different endogeneity identifications, including a natural experiment, alternative distance-to-default proxies, and different sub-samples. Overall, we present novel evidence of an adverse impact of firm-level political risk on distance-to-default and how such a negative effect can be mitigated.