Accounting Information, Investor Sentiment, and Market Pricing

Abstract

One of the most significant empirical findings of the behavioral finance literature is that investor sentiment affects asset prices. Baker and Wurgler (2006) finds that shares of certain firms—those that are difficult to value—are more affected by shifts in investor sentiment. We examine whether the accounting information of firms that are inherently difficult to value can mitigate sentiment-related mispricing. Our findings indicate that sentiment-related mispricing is in fact diminished in the subset of firms with high-quality accounting information. To better understand how accounting information mitigates stock market mispricing, we examine whether sentiment affects the choices made by sell-side stock analysts. When sentiment is high, analysts issue more favorable recommendations for firms that are more difficult to value, even though these firms appear to be overpriced and exhibit negative subsequent abnormal stock returns. However, this behavior is concentrated in the subset of difficult-to-value firms with low-quality accounting information.