Sell on the News: Differences of Opinion and Returns Around Earnings Announcements

Abstract

Miller (1977) hypothesizes that differences of opinion among investors about stock value result in overvaluation so long as some investors are short-sales constrained. Prior evidence on the role of differences of opinion for stock prices has not yielded convincing evidence. We test the Miller hypothesis by focusing on earnings announcements because such announcements generally reduce differences of opinion among investors and, hence, are also likely to reduce overvaluation if the Miller hypothesis is true. We provide statistically significant and economically meaningful evidence in support of the Miller hypothesis. We find that the three-day hedge returns (returns on low minus high differences of opinion stocks) around earnings announcements are 0.2749% (23% annualized) to 0.7132% (60% annualized), depending upon the proxy for differences of opinion. The results are robust to alternative explanations such as the effects of financial leverage, post-earnings-announcement-drift and earnings announcement premium. Additional analysis using institutional ownership as a proxy for short-sales constraints further strengthens our conclusions regarding the Miller hypothesis. We find that the association between differences of opinion and announcement period returns is magnified within the subsample of stocks that are most difficult for investors to sell short.