Firm Characteristics and the Pricing of Foreign Earnings of US Multinational Firms

Abstract

AbstractPrior research finds a positive relation between current changes in foreign earnings of USmultinational firms and future stock returns. The cause of this relation is either (1) investors' mispricing of securities by underestimating the persistence of foreign earnings or (2) research design misspecifications (e.g., the researcher failing to control for cross‐sectional differences in risk). The purpose of this study is to determine which of these two competing explanations is more likely. If the anomalous results are due to market mispricing, then the anomalous results should be more pronounced for firms that are followed by fewer well‐informed, sophisticated investors and for firms that have foreign earnings that are more persistent than domestic earnings. If the anomaly is related to research design misspecification, then the existence of the anomaly is not expected to vary across these firm characteristics. The results are more consistent with the market mispricing hypothesis. Predicting the existence of the foreign earnings anomaly based on these firm‐specific characteristics increases our understanding of the true nature of the anomaly. In addition, relating the foreign earnings anomaly to firm‐specific characteristics provides relevant information to investors for firm valuation and helps to promote future academic research in the market's valuation of multinational firms' operations.