Corporate goodness and profit warnings

Is a firm that is known for positively engaging stakeholders expected to voluntarily disclose bad financial news? If it makes the announcement, does its corporate goodness help to mitigate the stock price reaction? We examine these issues using a sample of profit warnings, and a sample of firms with negative earnings surprises that did not warn. Firms that have positive corporate social responsibility ratings are more likely to provide earnings warnings than other firms. When they do provide a profit warning, the event negative abnormal returns are of significantly smaller magnitude than the returns of other firms providing warnings. This effect does not occur for social firms that decide not to warn. They suffer the same negative stock price impact on the earnings announcement day as other firms.     

Intra-Industry Reactions to Stock Split Announcements

We examine whether favorable information conveyed by stock split announcements transfers to nonsplitting firms within the same industry. On average, nonsplitting firms' shareholders experience positive and significant abnormal returns at the stock split announcements of their industry counterparts. In addition, industrywide and firm-specific characteristics are important determinants in explaining nonsplitting firms' stock returns. These firms' earnings increase significantly, and the earnings changes are positively related to the stock price reactions. Finally, we find no evidence that investors revise the value of nonsplitting firms because they anticipate a decline in earnings volatility.     

Dividends, Asymmetric Information, and Agency Conflicts: Evidence from a Comparison of the Dividend Policies of Japanese and U.S. Firms

We compare dividend policies of U.S. and Japanese firms, partitioning the Japanese data into keiretsu, independent, and hybrid firms. We examine the correlation between dividend changes and stock returns, and the reluctance to change dividends. Results are consistent with the joint hypotheses that Japanese firms, particularly keiretsu-member firms, face less information asymmetry and fewer agency conflicts than U.S. firms, and that information asymmetries and/or agency conflicts affect dividend policy. Japanese firms experience smaller stock price reactions to dividend omissions and initiations, they are less reluctant to omit and cut dividends, and their dividends are more responsive to earnings changes.     

Earnings Behaviour of Financially Distressed Firms: The Role of Institutional Ownership

Using a sample of 859 U.S. bankruptcy-filing firms over the period 1986–2004, we examine the earnings behaviour of managers during the distressed period by looking at sources of abnormal accruals prior to the bankruptcy-filing year. Results show that managers of highly distressed firms shift earnings downwards prior to the bankruptcy filing. We test and provide evidence in support of two potential contributing factors. First, top-level management turnover among distressed firms leads new managers to earnings bath choices during the distressed period. Second, qualified audit opinions exert pressure on managers to follow more conservative earnings behaviour during the distressed period. Evidence is also provided that the management of distressed firms with lower (higher) institutional ownership has greater (lesser) tendency to manage earnings downwards. Results also show that higher institutional ownership mitigates the negative abnormal returns of firms with top management turnover. To the authors' knowledge, this is the first study that attempts to examine whether institutional ownership relates to market reaction in conjunction with a top management turnover or a qualified audit opinion during the distressed period. Prior studies focused on the investigation of earnings management or institutional ownership (separately) during the distressed period, but did not examine if the effect of institutional ownership on earnings behaviour also influences subsequent returns. Thus, the results of this study should be of interest to analysts, standard setters and regulatory bodies since our results show that management turnover, qualified audit opinions and firm governance mechanisms affect the quality of earnings and the level of abnormal returns.     

Inflation Illusion and Post-Earnings-Announcement Drift

This paper examines the cross‐sectional implications of the inflation illusion hypothesis for the post‐earnings‐announcement drift. The inflation illusion hypothesis suggests that stock market investors fail to incorporate inflation in forecasting future earnings growth rates, and this causes firms whose earnings growths are positively (negatively) related to inflation to be undervalued (overvalued). We argue and show that the sensitivity of earnings growth to inflation varies monotonically across stocks sorted on standardized unexpected earnings (SUE) and, consistent with the inflation illusion hypothesis, show that lagged inflation predicts future earnings growth, abnormal returns, and earnings announcement returns of SUE‐sorted stocks. Interestingly, controlling for the return predictive ability of inflation weakens the ability of lagged SUE to predict future returns of SUE‐sorted stocks.     

Pension Plan Funding and Stock Market Efficiency

The paper argues that the market significantly overvalues firms with severely underfunded pension plans. These companies earn lower stock returns than firms with healthier pension plans for at least 5 years after the first emergence of the underfunding. The low returns are not explained by risk, price momentum, earnings momentum, or accruals. Further, the evidence suggests that investors do not anticipate the impact of the pension liability on future earnings, and they are surprised when the negative implications of underfunding ultimately materialize. Finally, underfunded firms have poor operating performance, and they earn low returns, although they are value companies.     

Options trading volume and stock price response to earnings announcements

We examine the effect of options trading volume on the stock price response to earnings announcements over the period 1996–2007. Contrary to previous studies, we find no significant difference in the immediate stock price response to earnings information announcements in samples split between firms with listed options and firms without listed options. However, within the sample of firms with listed options stratified by options volume, we find that higher options trading volume reduces the immediate stock price response to earnings announcements. This conforms with evidence that stock prices of high options trading volume firms have anticipated and pre-empted some earnings information in the pre-announcement period. We also find that higher abnormal options trading volume around earnings announcements hastens the stock price adjustment to earnings news and reduces post-earnings announcement drift.     

Forecasting Japanese Stock Returns with Financial Ratios and Other Variables

This paper extends the previous analyses of the forecastability of Japanese stock market returns in two directions. First, we carefully construct smoothed market price–earnings ratios and examine their predictive ability. We find that the empirical performance of the price–earnings ratio in forecasting stock returns in Japan is generally weaker than both the price–earnings ratio in comparable US studies and the price dividend ratio. Second, we also examine the performance of several other forecasting variables, including lagged stock returns and interest rates. We find that both variables are useful in predicting aggregate stock returns when using Japanese data. However, while we find that the interest rate variable is useful in early subsamples in this regard, it loses its predictive ability in more recent subsamples. This is because of the extremely limited variability in interest rates associated with operation of the Bank of Japan’s zero interest policy since the late 1990s. In contrast, the importance of lagged returns increases in subsamples starting from the 2000s. Overall, a combination of logged price dividend ratios, lagged stock returns, and interest rates yield the most stable performance when forecasting Japanese stock market returns.     

The impact of hedging on the market value of equity

We examine the annual stock performance of firms that disclose the use of derivatives to hedge over the period 1995 to 1999. We find that only 21.6% of publicly traded U.S. corporations in our sample hedged with derivative instruments over this period and their use is concentrated in the larger companies. Similar to other studies we find that when derivatives are used, interest rate and currency securities are used much more frequently than commodity products. Our sample of 1308 companies that hedge outperforms other securities by 4.3% per year on average over our sample period. This result is robust to several alternative methods of estimating abnormal returns. When we segment performance by the type of hedge used, however, we find that the over-performance is due entirely to larger firms that hedge currency. We find no abnormal returns for firms hedging either interest rates or commodities. The abnormal returns in firms hedging currency is robust to alternative models that seek to control for exchange rate fluctuations and global equity returns; however, we find no significant abnormal returns to currency hedgers when using an augmented model that controls for the role of intangible assets.     

Evidence that Analyst Following and Institutional Ownership Accelerate the Pricing of Future Earnings

This paper presents evidence that prices of firms followed by sell-side analysts and favored by institutional investors incorporate future earnings earlier than prices of other firms. We conduct two sets of empirical tests: the first examines coefficients from regressions of returns on lead, contemporaneous, and lag earnings changes; the second compares the timing of monthly abnormal returns from earnings-based zero-investment portfolios. In both sets of tests, the results for analysts and institutions are incremental to each other. In addition, neither the analyst price lead nor the institutional price lead is due to price leads increasing with firm size.     

Earnings Quality Measures and Excess Returns

This paper examines how commonly used earnings quality measures fulfill a key objective of financial reporting, i.e., improving decision usefulness for investors. We propose a stock‐price‐based measure for assessing the quality of earnings quality measures. We predict that firms with higher earnings quality will be less mispriced than other firms. Mispricing is measured by the difference of the mean absolute excess returns of portfolios formed on high and low values of a measure. We examine persistence, predictability, two measures of smoothness, abnormal accruals, accruals quality, earnings response coefficient and value relevance. For a large sample of US non‐financial firms over the period 1988–2007, we show that all measures except for smoothness are negatively associated with absolute excess returns, suggesting that smoothness is generally a favorable attribute of earnings. Accruals measures generate the largest spread in absolute excess returns, followed by smoothness and market‐based measures. These results lend support to the widespread use of accruals measures as overall measures of earnings quality in the literature.     

Abnormal trading volume,news and market efficiency: Evidence from the Jamaica Stock Exchange

This paper investigates market efficiency of the Jamaica Stock Exchange (JSE). Together, weak and semi-strong form efficiency claim that historical and newly released public information do not predict future stock price movement. We test both forms of market efficiency by analyzing stock price behavior during times of abnormal trading volume and around the release dates of earnings information. Abnormal trading volume may be driven by liquidity demand or reflect new or private information flow to the market. Using JSE data over the period 2000 to 2021, we find price dynamics consistent with price pressure as firms experience negative abnormal returns on the day of abnormal trading activity but offsetting positive abnormal stock returns on the following day. Further findings show post earnings announcement drift on the JSE. Taken as a whole, the evidence suggests violations of market efficiency and has implications for capital allocation in this emerging market.     

Unfunded pension liabilities and stock returns

This paper investigates whether the market rationally anticipates the value implications of unrecognized pension obligations, using a large sample of Japanese firms where pension obligations are substantially underfunded. If a firm's unrecognized pension obligation is not incorporated into its share price, its stock returns will be lower than those of other firms, because its deficit will affect the firm's income statement in the coming years. We find that firms with large unrecognized obligations earn lower risk-adjusted returns. This evidence suggests that the market does not efficiently incorporate information in the pension items.     

Loss firms’ annual report narratives and share price anticipation of earnings

We extend prior research into the association between disclosure quality and share price anticipation of earnings by discriminating between firms that report profits and firms that report losses. As a measure of disclosure quality we count the number of forward-looking earnings statements in annual report narratives. To measure the extent to which current share price movements anticipate future earnings changes we regress current stock returns on current and future earnings changes. The coefficients on the future earnings change variables are our measure of share price anticipation of earnings.Our regression results show that the association between annual report narratives and share price anticipation of earnings is not the same for profit and loss firms. For loss firms we find that the ability of stock returns to anticipate next period's earnings change is significantly greater when the firm provides a large number of earnings predictions in annual report narratives. We make no such observation for profit firms. In addition, once we control for variations in the intrinsic lead–lag relation between returns and earnings across industries, the observed difference between profit and loss firms becomes statistically significant. Overall, our results are consistent with annual report narratives being a particularly important source of information for loss-making firms.     

Exchange Rate Exposure at the Firm and Industry Level

Previous work on the exposure of firms to exchange rate risk has primarily focused on U.S. firms and, surprisingly, found stock returns were not significantly affected by exchange‐rate fluctuations. The equity market premium for exposure to currency risk was also found to be insignificant. In this paper we examine the relation between Japanese stock returns and unanticipated exchange‐rate changes for 1,079 firms traded on the Tokyo stock exchange over the 1975–1995 period. Second, we investigate whether exchange‐rate risk is priced in the Japanese equity market using both unconditional and conditional multifactor asset pricing testing procedures. We find a significant relation between contemporaneous stock returns and unanticipated yen fluctuations. The exposure effect on multinationals and high‐exporting firms, however, is found to be greater in comparison to low‐exporting and domestic firms. Lagged‐exchange rate changes on firm value are found to be statistically insignificant implying that investors are able to assess the impact of exchange‐rate changes on firm value with no significant delay. The industry level analysis corroborates the cross‐sectional findings for Japanese firms in that they are sensitive to contemporaneous unexpected exchange‐rate fluctuations. The co‐movement between stock returns and changes in the foreign value of the yen is found to be positively associated with the degree of the firm's foreign economic involvement and inversely related to its size and debt to asset ratio. Asset pricing tests show that currency risk is priced. We find corroborating evidence in support of the view that currency exposure is time varying. Our results indicate that the foreign exchange‐rate risk premium is a significant component of Japanese stock returns. The combined evidence from the currency exposure and asset pricing analyses, suggests that currency risk is priced and, therefoe, has implications for corporate and portfolio managers.     

When the Japanese stock market meets COVID-19: Impact of ownership,China and US exposure,and ESG channels

We identify factors affecting the Japanese stock market during the COVID-19 pandemic period. First, we focus on the ownership structure. We find that indirect ownership through the exchange-traded fund purchasing program by the Bank of Japan has a positive impact on abnormal returns. Foreign ownership is negatively associated with abnormal returns, whereas ownership by traditional business groups is positively associated with abnormal returns. Second, we examine the impact of global value chains and find that stock returns are lower for companies with China and U.S. exposure. Third, in terms of environmental, social, and governance (ESG) engagement, there is no evidence that firms that have highly rated ESG scores have higher abnormal returns, but firms with ESG funds outperform those without.     

What drives the market value of firms in the defense industry?

This article assesses the relative importance of different types of news in driving significant stock price changes in the defense industry. We implement a systematic event study with the 58 largest publicly listed companies in the defense industry, over the time period 1995-2005. We first identify, for each firm, the statistically significant abnormal returns over the time period. Then, we look for information releases likely to cause such stock price movements. Most of the key drivers in the defense industry are the same as in other industries (key role of formal earnings announcements and analysts’ recommendations) but we also identify some specific features, in particular the influence of geopolitical events and the relevance and frequency of bids and contracts on stock prices. Finally, we examine the impact of the September 11 terrorist attacks on defense firms.     

The impact of regulation FD on the information environment: evidence from the stock market response to stock split announcements

This paper examines the information environment effects of regulation fair disclosure (Reg FD). We investigate the stock market response to stock splits in the pre- and post-regulation periods. We find that abnormal returns around split announcement are positive in both periods, but the magnitude of the returns is smaller in the post-FD period relative to the pre-FD period. The difference between the pre- and post-FD period abnormal returns persists even after we control for factors that may affect split announcement returns. We also find that the magnitude of the association between announcement returns and the unexpected portion of the split factor has increased post-regulation. Our analysis of performance trends for split firms reveals that patterns of profitability and changes in profitability in the years around stock splits are similar in the pre- and post-FD periods. However, we find that announcement returns are associated with lagged profitability changes in the pre-FD period, but with future profitability changes in the post-FD period. Collectively, our results imply that Reg FD has reduced information asymmetry and improved price efficiency.     

Short Selling and Earnings Management: A Controlled Experiment

During 2005 to 2007, the SEC ordered a pilot program in which one‐third of the Russell 3000 index were arbitrarily chosen as pilot stocks and exempted from short‐sale price tests. Pilot firms’ discretionary accruals and likelihood of marginally beating earnings targets decrease during this period, and revert to pre‐experiment levels when the program ends. After the program starts, pilot firms are more likely to be caught for fraud initiated before the program, and their stock returns better incorporate earnings information. These results indicate that short selling, or its prospect, curbs earnings management, helps detect fraud, and improves price efficiency.     

The Pricing of Relative Performance Based Incentives for Executive Compensation

Japanese firms report both parent-only and consolidated financial statements. Because of the unique business environment in Japan, there is a widely held view that parent-only data provides a better means for assessing the value of the entire firm. We find that both parent-only and subsidiary earnings are important in predicting future consolidated earnings. However, while stock prices accurately reflect the persistence of parent-only earnings, the Japanese stock market appears to underestimate the persistence of subsidiary earnings, causing a significant positive relation between changes in subsidiary earnings in year t and stock returns in year t +1. This relation between subsidiary earnings and future stock returns does not persist beyond year t 7plus;1. Taking a long (short) position in firms with large, positive (negative) changes in subsidiary earnings results in an average annual abnormal return of 7.06% with positive returns in 12 of the 13 years in the test period.