06 Financial Accounting 1: Financial analysts/equity valuation (FAR1)
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ItemAnalyst Monitoring of Opportunistic Firm Behavior( 2022)Prior literature presents mixed evidence about analyst monitoring of opportunistic firm behavior. We find that analysts reduce annual earnings forecasts as well as target prices around earnings announcements of the first three quarters of the fiscal year as if they punish a firm’s accrual-based and real earnings management during the quarters. The forecast reductions are more pronounced when analysts have less conflicts of interest with the firm (i.e., when analysts are employed by smaller brokers and when they are less experienced) and when analysts are less influential and less accurate. We also find that the firm responds to analyst monitoring by reversing its opportunistic behavior during the subsequent quarter. The reversals are more pronounced when the firm relies more on analyst optimism (i.e., when the firm has a lower market capitalization, higher market-to-book ratio and greater use of external financing). Collectively, our findings shed light on the dynamics of analyst monitoring by documenting sequential actions of analysts and the firm after the firm’s opportunistic behavior.
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ItemEmotional Media Content, Profitability Growth, and Long-term Return Reversals( 2022)We distinguish textual tone—the balance of positive and negative words—with emotional versus factual content and posit that media tone only with emotional content represents investor sentiment. Consistent with this hypothesis, a High-Minus-Low portfolio formed on firm-specific media tone generates large negative three-year alphas of up to -18% when content is emotional but insignificant alphas when factual. The significant alphas arise only from the idiosyncratic component of media tone. The return reversal pattern synchronizes with reversals in profitability growth (ROE). Overall, emotional media tone captures overreaction to past profitability growth and subsequent correction of mispricing in the long run.
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ItemProduction Complementarity and Momentum Spillover Across Industries( 2022)Economic theory suggests production complementarity is an important driver of sectoral co-movements and business cycle fluctuations. We operationalize this concept by developing a measure of the production complementarity distance (COMPL) between any two companies. We find firms from different industries that are closely aligned in terms of COMPL exhibit strong co-movement in both fundamentals and stock returns. Further, we find a strong lead-lag effect in returns, such that a long-short strategy based on recent COMPL peer returns yields a monthly alpha of 137 basis points, with no reversals. This inter-industry momentum effect is not explained by common risk factors or other network-based effects such as industry membership, customer-supplier relations, and shared analyst coverage. We conclude cross-industry news transfer occurs along complementarity networks, but stock prices do not update instantaneously.
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ItemSell-Side Analysts’ Assessment of Operational Risk: Evidence from Negative ESG( 2022)Financial analysts closely follow a firm’s operations and assess the risks that it faces. Operational risks have value implications to firms, and as such are expected to be reflected in analysts’ outputs. In this paper, we examine whether analysts incorporate assessments of operational risks. We use firm-day level data from RepRisk about negative operational incidents that are classified into environmental, social, and/or governance issues. We find that analyst outputs predict negative ESG incidents, suggesting that analyst outputs contain information that is predictive of these events. Our results are robust to controlling for negative ESG incidents that firms experienced in the past, and are stronger in more transparent information environments, and in the presence of more guidance on ESG issues from Sustainability Accounting Standards Board. Finally, we find that these ESG risks are incorporated into analyst outputs through adjustments to discount rates rather than to cash flow estimates. Overall, our results highlight the ability of financial analysts to synthesize and integrate operational risks, and in particular ESG-related risks, into their research outputs.
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ItemCross-sectional variations in the valuation role of investment growth( 2022)Real options models show a stepwise increase in the value-earnings association as accounting profitability increases and guides managerial investment decisions. However, we expect the role of investment growth in valuation to vary depending upon whether tangible or intangible investments support the investment growth. We find that value is less strongly associated with earnings when intangibles support investment growth. We attribute the differential value-earnings association across tangibles- vs. intangibles-supported investment growth to underinvestment in intangibles under the mandatory expensing accounting regime. We also find that the differential value-earnings association is increasing in financial constraints. We attribute this finding to the fact that financial constraints exacerbate the underinvestment problem by curtailing or delaying risky intangible investments. Lastly, we find that the differential value-earnings relation is limited to firms with low compensation convexity. We attribute this finding to the efficacy of managerial risk-taking incentives of compensation convexity because option vega helps mitigate the underinvestment problem by inducing executives to take up risky intangible investments. We contribute to the literature by documenting cross-sectional variations in the feedback role of accounting profitability.
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ItemThe Role of Employees as Information Intermediaries: Evidence from Their Professional Connections( 2022)This paper investigates whether employees in conjunction with their professional networks function as information intermediaries. Collectively, employees have access to value-relevant information that can be distributed through both their direct professional contacts and the contacts of their contacts. We find that firms with more highly connected employees have more efficient prices with respect to earnings-related information. More highly connected firms have lower abnormal returns and trading volume reactions by retail investors around earnings announcements. These results hold for both executive and non-executive employees. In addition, stock prices incorporate earnings-related information on a more-timely basis over the quarterly earnings cycle when employees are more connected. Finally, we find that retail order imbalances predict the cross-section of future stock returns for firms with highly connected employees. Overall, our findings suggest that employees and their professional connections play an important role as information intermediaries, thereby increasing the information efficiency of stock prices.
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ItemConcurrent Earnings Announcements and the Allocation of Investor Attention( 2022)Information choice models predict that investors should prioritize the processing of aggregate over firm-specific information, yet recent empirical evidence documents a complementary relation between these two types of information. We reconcile this apparent disconnect by showing that investors treat aggregate and firm-specific information as substitutes when their information processing capacity is constrained, a key assumption in information choice models. We show that when investors are capacity constrained, namely on busy earnings announcement days, they acquire more macroeconomic information and trade securities exposed to macroeconomic uncertainty more extensively. Moreover, on these days aggregate uncertainty declines while firm-specific uncertainty increases.