Unsophisticated Arbitrageurs and Market Efficiency: Overreacting to a History of Underreaction?

Prior research has documented that arbitrage activity significantly reduces or eliminates stock market anomalies. However, if anomalies arise due to unsophisticated investors’ behavioral biases, then these same biases can also apply to unsophisticated arbitrageurs and thereby disrupt the arbitrage process. Consistent with a disruption in the arbitrage process for the post‐earnings announcement drift anomaly, I document that the historically positive autocorrelation in firms’ earnings announcement news has become significantly negative for firms with active exchange‐traded options. For these easy‐to‐arbitrage firms, the firms in the highest decile of prior earnings announcement abnormal return (prior earnings surprise), on average, underperform the firms in the lowest decile by 1.59% (1.43%) at their next earnings announcement. Additional analyses are consistent with investors learning about the post‐earnings announcement drift anomaly and overcompensating. This study suggests that unsophisticated attempts to profit from a well‐known anomaly can significantly reverse a previously documented stock return pattern.     

Do more reputable financial institutions reduce earnings management by IPO issuers?

This study investigates whether financial intermediaries (FIs) participating in the IPO process play a significant role in restraining earnings management (EM). Specifically, we examine whether EM around IPOs is negatively related to investment banks (IBs) and venture capital (VC) investor reputations. In general, we do not find evidence that VCs as a group significantly restrain EM by IPO issuers. However, we uncover strong evidence that more reputable VCs and IBs are associated with significantly less EM, which is consistent with them implicitly certifying the quality of issuer financial reports. Moreover, a stronger reduction in EM is found when more reputable IBs are matched with more reputable VCs, which indicates that VC and IB reputation are complements rather than substitutes. These conclusions are invariant to adjustments for potential endogeneity of underwriter reputation and VC-backing or reputation.     

Seasoned equity offerings: Quality of accounting information and expected flotation costs

Flotation costs represent a significant loss of capital to firms and are positively related to information asymmetry between managers and outside investors. We measure a firm's information asymmetry by its accounting information quality based on two extensions of the Dechow and Dichev [2002. The quality of accruals and earnings: the role of accrual estimation errors. Accounting Review 77, 35–59] earnings accruals model, which is a more direct approach to assessing the information available to outside investors than the more commonly used proxies. Our main hypothesis is that poor accounting information quality raises uncertainty about a firm's financial condition for outside investors, though not necessarily for insiders. This accounting effect lowers demand for a firm's new equity, thereby raising underwriting costs and risk. Using a large sample of seasoned equity offerings (SEOs), we show that poor accounting information quality is associated with higher flotation costs in terms of larger underwriting fees, larger negative SEO announcement effects, and a higher probability of SEO withdrawals. These results are robust to joint determination of offer size and flotation cost components and to adjustments for sample selection bias.     

Analyst characteristics, timing of forecast revisions, and analyst forecasting ability

We first examine whether analysts with certain characteristics that prior research has identified are related to superior forecasting ability systematically time their forecast revisions later in the fiscal quarter. We then examine whether this superior ability persists after controlling for the timing advantage by using relative forecast error, a measure that largely eliminates the timing advantage of recent forecasts. Using a sample of quarterly earnings forecast revisions over the 20-year period from 1990 to 2009, we find that analysts with more firm-specific and general experience and more accurate prior-period forecasts, analysts employed by larger brokerage firms, and analysts who follow fewer industries and companies tend to revise forecasts later in the quarter. We also find that analyst characteristics that are positively correlated with revision timing are negatively related to relative forecast errors. These results are consistent with analyst characteristics being useful proxies for analyst forecasting ability and analysts with greater ability revising forecasts later in the quarter.     

What drives cross-segment diversity in returns and risks? Evidence from Japanese and U.S. firms

The usefulness of segment reporting is grounded on the presumption of diversities of returns and risks across reported segments. We examine the effect of country-specific factors, reporting incentives, and choices on an ANOVA-based measure of cross-segment diversities (CSD) in risk and returns for a sample of Japanese and U.S. multi-segment firms. We find that, in contrast to our expectations, Japanese firms exhibit greater CSD than U.S. firms. Moreover, we find that in both countries CSD is driven especially by reporting incentives associated with profitability and foreign sales, but not by proprietary costs. Further, the manager's choice of the number of reported segments is an important factor affecting CSD.     

Linguistic Complexity in Firm Disclosures: Obfuscation or Information?

Prior research generally interprets complex language in firms’ disclosures as indicative of managerial obfuscation. However, complex language can also reflect the provision of complex information; for example, informative technical disclosure. As a consequence, linguistic complexity commingles two latent components—obfuscation and information—that are related to information asymmetry in opposite directions. We develop a novel empirical approach to estimate these two latent components within the context of quarterly earnings conference calls. We validate our estimates of these two latent components by examining their relation to information asymmetry. Consistent with our predictions, we find that our estimate of the information component is negatively associated with information asymmetry while our estimate of the obfuscation component is positively associated with information asymmetry. Our findings suggest that future research on linguistic complexity can construct more powerful tests by separately examining these two latent components of linguistic complexity.     

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.     

THE FUNDAMENTAL DETERMINANTS OF TRADING VOLUME REACTION TO FINANCIAL INFORMATION: EVIDENCE AND IMPLICATIONS FOR EMPIRICAL CAPITAL MARKET RESEARCH

Prior empirical research indicates that trading volume reaction to new information increases with the heterogeneity of investors’ prior beliefs. We examine three potential factors that theoretical models of financial economists show determine trading volume reaction to new information: heterogeneous prior beliefs, differential interpretation, and the consensus effect—the extent to which the information causes their beliefs to converge or diverge. We find that these three factors have a distinct and significant incremental effect on trading volume, thereby suggesting that empirical trading volume models that exclude or fail to control for any of these determinants are misspecified with biased estimated coefficients.     

The Value of Crowdsourced Earnings Forecasts

Crowdsourcing—when a task normally performed by employees is outsourced to a large network of people via an open call—is making inroads into the investment research industry. We shed light on this new phenomenon by examining the value of crowdsourced earnings forecasts. Our sample includes 51,012 forecasts provided by Estimize, an open platform that solicits and reports forecasts from over 3,000 contributors. We find that Estimize forecasts are incrementally useful in forecasting earnings and measuring the market's expectations of earnings. Our results are stronger when the number of Estimize contributors is larger, consistent with the benefits of crowdsourcing increasing with the size of the crowd. Finally, Estimize consensus revisions generate significant two‐day size‐adjusted returns. The combined evidence suggests that crowdsourced forecasts are a useful supplementary source of information in capital markets.     

Commemorating the 50‐Year Anniversary of Ball and Brown (1968): The Evolution of Capital Market Research over the Past 50 Years

We commemorate the 50th anniversary of Ball and Brown [1968] by chronicling its impact on capital market research in accounting. We trace the evolution of various research paths that post–Ball and Brown [1968] researchers took as they sought to build on the foundation laid by Ball and Brown [1968] to create a body of research on the usefulness, timeliness, and other properties of accounting numbers. We discuss how those paths often link back to the groundwork laid and questions originally posed in Ball and Brown [1968].