Simultaneous Presence of Different Domestic GAAPs and Investors’ Limited Attention Bias in U.S. Equity Markets: Implications for Convergence*

Abstract

I examine how the presence of domestic accounting standards of various countries affects market reactions to firms’ earnings announcements on a given day and subsequent post-earnings announcement drifts (PEAD) in U.S capital markets. Drawing from the finance and accounting literatures on investors’ limited attention bias, I posit that the presence of fewer multiple domestic GAAPs reduces investors’ cognitive burdens to analyze earnings of firms from different countries and thus results in less distraction and stock mispricing when investors respond to firms’ earnings news. I use the number of domestic GAAPs at the firm level on a given earnings announcement day as the proxy for extent of simultaneous presence of domestic GAAPs and test the incremental effects of the number of domestic GAAPs on initial market reactions to earnings and on PEAD of U.S. and non-U.S. firms. I find that the presence of fewer different domestic GAAPs yields higher earnings response coefficients and trading volume reactions to firms’ earnings news and induces a smaller incremental effect on PEAD. A hedge portfolio based on PEAD on earnings announcement days with fewer domestic GAAPs is less profitable than one based on announcement days with more domestic GAAPs. The results indicate that the presence of fewer domestic GAAPs facilitates investment decision making and improves market efficiency by mitigating investors’ limited attention bias. The findings provide the important implication for the current movement of convergence of domestic accounting standards. This is also the first paper to empirically investigate the relation between different domestic GAAPs and investors’ limited attention bias.