Firm Fundamentals Research Articles

Covid-19 and firm communication: how do mobility constraints affect the conference call sentiment?

ABSTRACT During the COVID pandemic, the mobility of individuals is largely reduced. This paper is to investigate how this immobility-induced social isolation affects conference calls sentiment. We employ several exogenous events: first death via COVID in the county, declaration of State of Emergency, and Stay at Home Order. We find a consistent result that mobility constraints decrease the sentiment within earnings calls. Our findings suggest the variation of mobility constraints impacts manager mood and further influences short-term market returns beyond firm fundamentals. Our results remain significant after using alternative proxies for mobility constraints and focusing on the manager’s specific sentiment usage.

Agreeing to disagree: Informativeness of sentiments in internet message boards

We study the informativeness of the sentiment of posts on Australia's largest online stock message board, HotCopper. We explore whether disagreements among sentiment form a signal about the fundamental news of a company. We find that positive sentiment is associated with noise induced (uniformed) trading whereas negative sentiment contains value-relevant information about a firm's performance. Our empirical findings suggest that short selling activity reduces overreactions of abnormal returns in a noisy environment on the same day. Furthermore, we observe a sentiment convergence pattern around annual earnings announcements and low levels of sentiment homogeneity relate to significantly lower annual earnings surprise. This supports the view that disagreements among sentiments are a signal of bad news about firm fundamentals.

Sequential Reporting Bias

ABSTRACT Firms with correlated fundamentals often issue reports sequentially, leading to information spillovers. The theoretical literature has investigated multifirm reporting, but only when firms report simultaneously. We examine the implications of sequential reporting, where firms aim to maximize their market price and can manipulate their reports. The introduction of sequentiality significantly alters the biasing behavior of firms and the resulting informational environment relative to simultaneous reporting. In particular, a lead firm always manipulates more when reports are issued sequentially. Moreover, relative to simultaneous reporting, sequential reporting reduces the overall information available to the market about each firm, resulting in less efficient and less volatile prices. Additionally, we find that stronger correlation in firm fundamentals can amplify the lead firm’s incentive for manipulation under sequentiality, in contrast to simultaneous reporting. We offer further results regarding, for example, market response coefficients, and provide a number of empirical implications. JEL Classifications: C72; D82; D83; G14; M41.

Insider trading and climate disasters

Climate disasters are increasing in frequency and severity. While a large body of research has shown that extreme climate affects various economic decisions, how climate events influence investment decisions remains largely under-investigated. This paper examines whether, and to what extent, climate disasters influence insider transactions, which are important investment decisions that attract increasing attention from both corporate management and policymakers. We find that the monthly value of insider trades increases markedly in firms headquartered in counties with a climate disaster. Climate-induced insider trading holds in general but is stronger when investors are distracted and less prevalent when insiders face higher litigation risk. Climate disasters trigger uncertainty about short-term firm fundamentals, and insiders benefit by selling prior to this being priced. Insiders living in disaster counties do not trade more than those in unaffected counties, which does not support a personal liquidity motivation. Our paper documents a new way through which climate impacts investor behavior and financial markets.

Preference dynamics and risk-taking incentives

This study explores the relationship between executive compensation and the preference dynamics of managers and shareholders. Our analysis centers on the theoretical prediction that changes in firms' asset value can differentially affect the risk-taking preferences of the two groups, potentially influencing the optimal compensation policy. Utilizing local real estate price changes to identify variations in firms’ asset value, we find that a decrease in asset value leads to more risk-taking incentives in compensation, and this effect is more pronounced in firms that are more likely to be influenced by the hypothesized mechanisms. In the second empirical setting, we provide corroborating evidence using a natural experiment involving disaster-induced negative shocks to the firm fundamentals. Collectively, our findings suggest that the design of compensation contracts facilitates incentive alignment by incorporating the dynamic preferences of the contracting parties.

Audit committee member busyness and risk factor disclosure

Audit committees in the U.S. oversee risk management within organizations, including oversight of the disclosure of risk factors in periodic filings. Because audit committees have become increasingly over-burdened, we examine the impact of the busyness of audit committee members, measured via members’ service on other boards, on risk factor disclosures. We find firms with busy members issue disclosures that are of lower quality (i.e., less readable and less focused on firm fundamentals). Further, we find that firms with busy members are more likely to issue timely updates to disclosures. However, these updates are more likely to be vague—implying they are inconsequential to the market. We find these results are primarily driven by service in other non-audit committee roles. In additional cross-sectional tests, we find that our results are strongest when there is more uncertainty or complexity in the business environment. Finally, additional specifications and tests show that our results are robust to concerns related to endogeneity. Overall, we find that the busyness of audit committee members has important implications for risk factor disclosures.

Brexit and the fintech revolution in Europe: lessons from the Bulgarian digital finance sector

Purpose This paper aims to investigate the drivers of the resilience of the fintech sector in emerging Europe (EU) by analyzing the performance of 128 Bulgarian fintech companies in the period around the Referendum for Brexit in 2016. The Referendum was followed by a rapid growth of the Bulgarian fintech sector at a moment when venture capital funding was limited, which challenged firms to improve their fundamentals. Design/methodology/approach This empirical paper uses descriptive and panel data analysis based on the firm balance sheet and income statement data at the annual level. Findings The results show that larger and better-capitalized firms, which outsource their non-core activities and focus on their main competitive strengths, tend to have higher operating income and profit. The authors also find positive real-economy effects as these companies hire more actively to maintain growth. The results are primarily driven by the post-Brexit period of 2016–2019 when the authors find a tighter link between performance and firm fundamentals. These results have important managerial and policy implications and provide interesting directions for future research. Practical implications The findings have important management and policy implications. The authors argue that the flexibility of the Bulgarian fintech cluster, including the practice of Bulgarian fintech startups to outsource non-core activities; the readiness of universities to open new master programs to address firm demand for skilled labor and the startup-friendly environment in the main cluster hotspot, Sofia, has contributed to the resilience of the sector and can explain the drivers behind our findings. Fintech firms are very efficient in utilizing external services to foster their performance and growth, which may suggest that public policies that provide financial support for cloud services and outsourcing for startups during downturns or crises may improve economic growth and may have positive externalities for the supporting sectors that provide these services. Originality/value This paper fulfills an identified need to study the drivers of Fintech performance to identify best practices for managerial actions during economic or political crises, as well as government policy recommendations. To the best of the authors knowledge, this is one of the first empirical academic studies that examine the impact of Brexit on the European Fintech sector and real economy. The identified managerial strategies for ensuring regional resilience to economic crises and political shocks can be applied in various settings within and outside the EU.

Missing Financial Data

Abstract We document the widespread nature and structure of missing observations of firm fundamentals and show how to systematically handle them. Missing financial data affects more than 70% of firms that represent about half of the total market cap. Firm fundamentals have complex systematic missing patterns, invalidating traditional approaches to imputation. We propose a novel imputation method to obtain a fully observed panel of firm fundamentals that exploits both time-series and cross-sectional dependency of data to impute missing values and allows for general systematic patterns of missingness. We document important implications for risk premiums estimates, cross-sectional anomalies, and portfolio construction. (JEL C14, C38, C55, G12)

Shared analyst coverage, 52-week high, and cross-firm return predictability

In this study, we show that the return predictability of analyst-connected firms is positively correlated with nearness to 52-week high stock prices. Our results are robust to tax loss selling and penny stocks and when controlling for market factors and macroeconomic conditions. The impact of the 52-week high on the analyst-connected momentum effect is stronger among focal stocks of smaller firms, those with lower institutional ownership, and those with less analyst coverage. Moreover, the greater the number of shared analysts, the stronger the relationship between firm fundamentals, resulting in stronger return predictability. When both focal and analyst-connected firms have stock prices near (far from) their 52-week highs, there is a stronger underreaction to good (bad) news about analyst-connected firms.

From macro to micro: Sparse macroeconomic risks and the cross-section of stock returns

Our study presents novel evidence on the pricing effectiveness of macroeconomic risks at the firm level. We employ a sparse PCA approach to aggregate macroeconomic variables from the FRED-MD database and obtain the first eight components, namely inflation, housing, spreads, production, employment, personal income, yields, and credit. We then construct the corresponding firm-level macroeconomic risk exposures as the sensitivity of the individual stock returns to the sparse economic components. Our research yields three main findings: (i) macro betas cannot be fully captured by common firm fundamentals, indicating the unique information in macro betas; (ii) the betas of inflation, production, personal income, yields, and credit are strong predictors of future stock returns beyond other micro risks; and (iii) behavioral mispricing theory, especially arbitrage frictions and investor sentiment, can help explain the macro beta premium.

Cost Structure and the Usefulness of Earnings

We investigate the relation between the usefulness of earnings and firm cost structure. We document that the usefulness of earnings to external users decreases in the degree of operating leverage, which measures the proportion of fixed to variable costs, and that this decline extends at least partially from the relation between the degree of operating leverage and two earnings properties: aggressive revenue recognition to meet an earnings target and earnings volatility. Our results illustrate how firm fundamentals influence a firm’s information environment and thereby the usefulness of earnings to external users. This paper was accepted by Ranjani Krishnan, accounting. Supplemental Material: The data files are available at https://doi.org/10.1287/mnsc.2021.03023 .

Do natural disasters affect stock price crash risk? Evidence from emerging markets

This study shows a significantly positive relationship between natural disasters and firm-level stock price crash risk using a sample of listed firms from emerging markets.The channel tests suggest that natural disasters affect crash risk by increasing corporate risk-taking, dampening firm fundamentals, and aggravating bad news hoarding. The research further identifies that the effect of natural disasters on crash risk is moderated by country-level and firm-level characteristics. Overall, our findings contribute to a broader understanding of the economic outcomes of natural disasters in emerging markets.

The economic-based earnings persistence of earnings momentum and its market implications

PurposePrior research on meeting or beating earnings thresholds documents that firms with earnings momentum are awarded with valuation premiums. However, it is unclear from this strand of literature why this is the case. Therefore, this study aims to investigate the effects of time-varying earnings persistence on earnings momentum and their pricing effects.Design/methodology/approachThis study exploits a firm that reports earnings momentum as research setting to examine whether earnings persistence is significantly higher for firms with consecutive earnings increases. In addition, it investigates a relation between earnings momentum and fundamentals-driven earnings persistence and estimates return associations of earnings momentum conditional on economic-based persistence of earnings.FindingsThe empirical evidence suggests that firms with earnings momentum reflect higher time-varying earnings persistence. It further reveals that longer duration of earnings momentum is associated with higher fundamentals-driven earnings persistence. More importantly, valuation premiums are exclusively assigned to earnings momentum determined by strong firm fundamentals, not momentum itself.Originality/valueThis study provides new empirical evidence that valuation premiums accrued to firms with earnings momentum are conditional on time-varying earnings persistence. The research implications are relevant to investors, regulators and auditors, as the results bring conclusions that earnings momentum reflects successful business models not poor accounting quality. This leads to a more complete view of earnings momentum and helps allocate resources when evaluating earnings-momentum firms.

Leveraged trading and stock returns: Evidence from international stock markets

Are margin traders as well-informed as short sellers when it comes to leveraged investing? Our paper, utilizing a unique dataset on stock-level short selling and margin trading from three international stock markets, reveals that while short selling has cross-sectional return predictability, margin trading does not. In comparison to short selling, margin-trading activities demonstrate a stronger correlation across stocks and weakly predict firm fundamentals. This suggests that margin traders are less likely to possess a firm-specific information advantage. Our findings at the investor account level also indicate that margin traders are less sophisticated than short sellers.

Measuring Financial Statement Disaggregation Using XBRL

ABSTRACT We develop a measure of disclosure quality using disaggregation of financial statement items from the Form 10-K XBRL filing. Our measure (ITEMS) extends Chen, Miao, and Shevlin’s (2015)DQ measure and is distinct from R. Hoitash and U. Hoitash’s (2018)ARC measure. Our measure provides a simple measure of disaggregation by counting the balance sheet and income statement line items, it does not depend on the data aggregators’ collection process and is readily available shortly after the Form 10-K is filed. We validate ITEMS by showing that firm fundamentals correlate to ITEMS in the predicted direction using OLS regression. We find that ITEMS explains consequences of disclosure quality: forecast error, forecast dispersion, bid-ask spread, and cost of equity capital. Further, ITEMS has explanatory power of disclosure quality consequences incremental to DQ and ARC, and it is distinct from ARC evident from different associations with disclosure quality consequences and reporting quality. Data Availability: Data are available from public sources identified in the text. JEL Classifications: M10; M40; M41.

Economics of Information Search and Financial Misreporting

ABSTRACTI examine how investors’ search for different types of information affects managers’ reporting decisions. I distinguish investors’ search for information about firm fundamentals (“fundamental search”) from their search for information about managers’ incentives (“incentive search”). Based on a parsimonious model of misreporting, I predict that fundamental search reduces the earnings response coefficient, which reduces managers’ benefits from misreporting, resulting in less misreporting. In contrast, incentive search increases the earnings response coefficient, which increases the benefits from misreporting, resulting in more misreporting. I test these predictions using an empirical technique that classifies EDGAR downloads as fundamental search or incentive search. Consistent with my theoretical predictions, I find that fundamental (incentive) search is negatively (positively) related to the earnings response coefficients and intentional restatements. I confirm my findings in two distinct empirical settings where the costs of information search exogenously changed: the adoption of XBRL and the electronic filing mandate of Form 4s. Collectively, the results show that investors’ information demand can shape managers’ reporting decisions, and its effects can vary depending on the type of information investors search for.

Information content of credit rating affirmations

AbstractWe examine the economic determinants and informational effects of credit rating affirmations (i.e., the reiteration of past credit ratings) for a sample of US public firms from 1995 to 2020. We find that credit rating affirmations typically follow major corporate events and changes in firm fundamentals that increase information uncertainty about a firm's creditworthiness, suggesting that affirmations reduce uncertainty. We further document that rating affirmations provide value‐relevant information to equity and debt investors. Using a short‐window event study method, we show that equity investors react positively to rating affirmations and that information uncertainty around affirmations diminishes. These findings are more pronounced for firms with non‐investment‐grade ratings. We further show that our results strengthen for firms with greater pre‐affirmation information uncertainty. Finally, consistent with our information uncertainty reduction results from the stock market, we report that bond yield spreads decrease for affirmed firms. Again, the effect is more pronounced for firms with non‐investment‐grade ratings. In summary, we highlight the significant capital markets' effects of credit rating affirmations, an area that the literature has largely ignored.

Impact of Firm’s Fundamentals on Return of Stocks in Nepal

Return on stock is the chief concern of firm investors. Investors prefer better stock returns, and management focuses on increasing stock returns for wealth maximization. Internal factors are the firm fundamentals, and external factors are various macroeconomic variables that influence stock returns. This paper uses descriptive and causality research designs to examine the impact of firm fundamentals on stock returns in Nepal for the fiscal year 2007/08-2021/22. In this paper, the dependent variable is stock return and firm fundamentals such as earnings per share (EPS), book-to-market equity (BME), size of market value of equity (lnME), cash flow yields (CFY), and earning yield (EY) are used as explanatory variables. The correlation result shows that EPS, BME, and EY have positive relationships, and lnME and CFY have negative relationships with stock returns. The regression results reveal the positive impact of EPS, BME, and EY on stock returns in Nepalese firms. This indicates that higher EPS, BME, and EY lead to increased firms’ stock returns. Further, the result reports that lnME and CFY have an inverse influence on returns. Finally, the finding concludes that earnings per share, book-to-market equity, size of market value equity, and cash flow yields are strong, but earnings yield has a weak impact on the stock returns of firms in Nepal. Policymakers, investors, and academicians can implement the findings of this study for effective formulation and application of policies, maximize stock returns, and research activities.

Non‐CEO executives' intraorganizational competition incentives and corporate labour investment efficiency

AbstractThis study examines the impact of non‐Chief Executive Officer (non‐CEO) executives' intraorganizational promotion‐based incentives, also known as tournament incentives, on corporate labour investment efficiency. We find that tournament incentives lead to inefficient labour investment, measured as the absolute deviation from optimal net hiring warranted by firm fundamentals. This positive relationship is weakened when non‐CEO executives are less eager to compete in the tournament. Mediating analysis demonstrates that reduced team cohesion, captured by non‐CEO executive turnover, mediates the relationship between tournament incentives and labour investment inefficiency. Our evidence is consistent with the dysfunctional view of tournament incentives and highlights the importance of non‐CEO executives' incentives in corporate labour investment.

The return predictability of carbon emissions: Evidence from Hong Kong and Singapore

We examine the relationship between carbon emissions and future stock returns in Hong Kong and Singapore stock markets. Hong Kong-listed stocks with higher carbon emissions experience lower future stock returns. The pattern is driven by non-local stocks and is absent among local stocks. Carbon emissions do not predict future returns in Singapore, where most of listed stocks are local. Investors of non-local firms in Hong Kong underreact to the effect of carbon emissions on firm fundamentals and environmental incidents. Moreover, the return predictability is stronger among stocks with higher information asymmetry, fewer sophisticated investors, and higher arbitrage costs.