10 Financial: Financial
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ItemSentiment, Loss Firms, and Investor Expectations of Future Earnings( 2019-09-01)This study investigates the mispricing of market-wide investor sentiment by exploring the relation between sentiment and investor expectations of future earnings. Prior research argues that sentiment-driven mispricing should be most pronounced for hard-to-value firms, such as those reporting losses (Baker and Wurgler 2006). Using investor expectations of future earnings, we provide empirical results consistent with this behavioral finance theory. In particular, we predict and find that investors perceive losses to be more (less) persistent during periods of low (high) sentiment; that investors perceive profit persistence to be lower (higher) during periods of low (high) sentiment; and that the effects appear stronger for loss firms relative to profit firms. In addition, we document predictable cross-sectional variation within losses, with the mispricing mitigated for losses associated with activities expected to generate future benefits: R&D, growth, large negative special items, and severe financial distress. Overall, our results document a new and important channel—investor expectations of future earnings—to explain sentiment-driven mispricing, particularly for loss firms.
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ItemDuPont Analysis and Firm Life Cycle( 2019-08-29)We extend Soliman’s (2008) study of the incremental information provided through DuPont analysis of return on net operating assets (RNOA) by examining pricing and mispricing of profit margin (PM) and asset turnover (ATO) across life-cycle stages (Dickinson 2011). We obtain additional insights by examining the incremental information provided by sub-components of RNOA for PM and ATO in different life-cycle stages. Consistent with life-cycle theory, we find that change in ATO is priced more strongly for mature firms than for other firms. This is due mainly to operating efficiency reflected in property, plant and equipment (PP&E) turnover and partially due to accounts receivable turnover. We find that change in PM is positively priced for both growth and mature firms. This reflects negative pricing of changes in cost of goods sold (COGS), selling, general and administrative (SG&A) expense and depreciation expense as a percentage of sales. Changes in research and development (R&D) costs as a percentage of sales are positively priced for mature firms but not positively or negatively priced for growth firms. We also find evidence that PM is underpriced for growth firms. This underpricing is due to mispricing of depreciation expense and R&D expense for growth firms, indicating that market participants do not fully value the information provided by these variables for future earnings.
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ItemCorporate Social Performance and Managerial Labor Market( 2019-08-29)This paper examines the impact of a firm’s social performance on the CEO’s employment prospects. We track departing CEOs’ subsequent employment records and find that the social performance of their previous employers improves their labor market outcomes. These CEOs are more likely to find a new executive position, and the new employer is more likely to be a publicly traded company. For the subsample of CEOs finding new executive positions at public firms, we find that a CEO whose previous employer has stronger social performance is more likely to move up to a larger firm. Finally, using a Cox proportional hazard model, we find that strong social performance of the previous employer helps CEOs find their next executive positions sooner. Overall, our results suggest that corporate social performance enhances CEOs’ labor market potentials.
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ItemContingent Information Content of Order Backlog and the Direction of Sales Change( 2019-08-29)We examine the contingent information content of order backlog and the direction of sales change. The more significant the order backlog, the less likely it is for future sales and thus earnings to decrease. As a result, an additional unit of order backlog predicts a more significant increase in future earnings and stock price when the firm also reports a sales decrease. The contingency of the information content is so significant that a sales decrease is no longer bad news when a firm reports above the top fiftieth percentile of order backlog relative to average assets. Our results support a contextual fundamental analysis theory in which the implication of an accounting measure can depend on other accounting information, and the impact of the context can be strong enough to overturn the qualitative interpretation.
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ItemActive Funds and Bundled News( 2019-08-28)We use trade-level data to examine the role of actively managed funds (AMFs) in earnings news dissemination. AMFs trade 170 percent more on earnings announcement (EA) days than on non-EA days. Abnormal AMF participation is disproportionately higher when earnings news is bundled with management guidance about future earnings. When the two pieces of information are directionally inconsistent, AMFs trade in the direction of guidance news rather than current earnings news. They exhibit an ability to discern, and adapt their trading to, the bias in managerial guidance. Further, we find that increased AMF trading during EAs reduces post-guidance price drift and leads to faster price adjustment. Collectively, our findings suggest AMFs are relatively sophisticated processors of bundled EA news, and their trading generally improves market price discovery.
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ItemInstitutional Ownership and the Propagation of Systemic Risk among Banks( 2019-08-27)We investigate whether institutional ownership (IO) plays a role in transmitting systemic risk through banks. We find robust evidence suggesting that IO is positively associated with future systemic risk. We find this relationship is stronger during economic downturns at the economy-wide level, as well as for banks demonstrating greater capital needs. Our results also suggest a trading mechanism through which active, and transient institutions in particular, play a role in propagating systemic risk. We find the relationship exists when there is both overlapping and non-overlapping ownership of banks, and the result is concentrated when there are low monitoring incentives for institutional owners. Furthermore, we find disclosure may play a role in mitigating the transmission of systemic risk by institutional investors. Overall, our results should be of interest to regulators, who have called for institutional investors to play a larger role in bank monitoring, and more broadly to the academic literature that tends to assume the benefits of IO without adequate consideration of the potential costs.
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ItemA Tale of Two Forecasts: An Analysis of Mandatory and Voluntary Effective Tax Rate Forecasts( 2019-08-21)We exploit a setting where firms provide two forecasts of the same underlying metric – effective tax rates (ETRs) – to examine the interaction between voluntary and mandatory disclosures. The integral method (ASC 740-270) requires firms to forecast de facto annual ETRs while some firms additionally provide voluntary ETR forecasts in earnings calls. Using a self-constructed dataset of voluntary ETR forecasts, we document that managers are more likely to issue voluntary ETR forecasts when tax complexity is higher. More importantly, voluntary ETR forecasts are incrementally informative over mandatory ETR forecasts as analysts revise their ETR forecasts based on the news in voluntary ETR forecasts, especially for voluntary non-GAAP ETR forecasts and in the presence of discrete tax items. Overall, our results suggest that managers resort to voluntary disclosure when mandatory disclosure constrains their ability to convey private information, thus we offer new insights on the interaction between voluntary and mandatory forward-looking disclosures.
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ItemCommon Ownership and Corporate Social Responsibility( 2019-08-14)This paper studies the effect of common ownership on corporate social responsibility (CSR). We find that common ownership is positively associated with a firm's social performance. Additional tests strength the causal interpretation of the results. The empirical evidence is consistent with the predictions from a model in which CSR serves as a strategic tool for a firm to strengthen its product market position.
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ItemIntra-Life Cycle Information Transfers( 2019-08-01)We investigate the presence of a shared life cycle component in earnings and test whether the earnings of one firm are relevant for valuing other firms in the same life cycle stage. We find that firm-pairs in the same life cycle stage have greater accounting comparability and greater co-movement in their returns, operating performance, and investments than firm-pairs consisting of firms in different life cycle stages. We further document economically significant transfers of information from announcing firms to non-announcing life cycle peers around an announcing firm’s earnings announcement. The magnitudes are comparable to that of intra-industry information transfers and do not depend on whether the life cycle peers are also active in the same industry. In contrast, we find that intra-industry information transfers are smaller for industry peers in different life cycle stages. Information transfers are stronger for life cycle peers that have greater (transient) institutional cross-holdings, suggesting that institutional trading is an important mechanism by which life cycle information spills over. Overall, this study provides insight into the factors that shape a firm’s earnings generation process and investors’ use of such factors. Furthermore, this study complements prior literature on firm life cycle by providing additional evidence on the importance of life cycle in the valuation process.