Limited Investor Attention Research Articles

Unobserved Performance of Hedge Funds

ABSTRACTWe investigate hedge fund firms’ unobserved performance (UP), measured as the risk‐adjusted return difference between a firm's reported gross return and its portfolio return inferred from its disclosed long‐equity holdings. Firms with high UP outperform those with low UP by 6.36% per annum on a risk‐adjusted basis. UP is negatively associated with a firm's trading costs and positively associated with intraquarter trading in equity positions, derivatives usage, short selling, and confidential holdings. We show that limited investor attention can delay investors’ response to UP and lead to longer lived predictability of fund firm performance.

Uncovering interfirm links through textual topic similarity: A comomentum analysis in financial markets

Using an unsupervised topic modelling methodology, we construct a cross-firm similarity measure based on the various topics extracted from Management Discussion and Analysis texts. Our findings indicate that the returns of firms with similar textual topics predict the focal firms’ future stock returns. A long-short portfolio constructed on this basis yields an annualised alpha of 17.03%. Further analyses show that the return predictability is stronger for stocks subject to limited investor attention and limits to arbitrage. Additionally, our textual linkage measure can also predict future earnings surprises. Overall, mispricing due to sluggish information incorporation acts as a potential explanation for return predictability.

Corporate information preference and stock return volatility

ABSTRACT This paper models the effect of corporate information preference on stock return volatility based on optimization problems of information decisions for firms and investors. Our model hypothesizes a positive correlation between corporate information preference and volatility. Utilizing the ideal institutional background of the Chinese stock market, we empirically confirm that corporate information preference has a positive impact on volatility, particularly for firms facing more severe financial distress, limited investor attention, and less analyst coverage. Our study provides a new perspective for analyzing the interaction between information supply and asset price dynamics.

The asymmetric effect of information shock on overnight and intraday expected returns: Evidence from Chinese A-share stock market

This study examines the impact of jumps in stock prices on the expected return and its components, overnight and intraday return. The findings reveal that a long-short jump return strategy generates positive risk-adjusted alphas for the close-to-close and overnight periods, but a negative alpha for the intraday period. These results are confirmed by Fama-MacBeth regressions. The positive premiums for the overnight and close-to-close periods are particularly evident for illiquid stocks and small firms. Further analysis indicates that it is positive jump returns, rather than negative jump returns, that primarily drive the positive (negative) overnight (intraday) return, as investors in the Chinese stock market tend to prefer buying winners. Lastly, limited investor attention is identified as a factor contributing to the heterogeneous effects of jumps on overnight and intraday return responses to information shock.

Disseminating information across connected firms — Analyst site visits can help

When information is disseminated across fundamentally connected firms at a fast pace, limited investor attention should be mitigated. We investigate whether analyst site visits to public firms have any impact on the lead–lag effect, a well-known phenomenon induced by limited investor attention. We find that analyst site visits to a focal firm’s connected firms almost eliminate the lead–lag effect between the visited connected firms and the focal firm at weekly frequency. The Fama–French five-factor alpha drops from 0.365% (t-statistic=3.26) per week for the strategy based on lagged returns of a firm’s non-visited connected firms to -0.082% (t-statistic=-0.97) per week for the strategy based on lagged returns of visited connected firms. We further provide evidence that analyst site visits to connected firms help improve forecast accuracy for the forecasted firm. These results indicate that analyst site visits help disseminate information across connected firms.

Limited investor attention and biased reactions to information: Evidence from the COVID-19 pandemic

We find that the COVID-19 pandemic increases (decreases) stock return sensitivity to market-wide (firm-specific) news, which is associated with return reversals (delayed reactions). These results are consistent with limited investor attention and investors paying heightened (reduced) attention to macro (micro) information after the outbreak. There are more biased reactions when the epidemic spread is higher, to good news than bad news, for firms headquartered in pandemic epicenters, and for larger stocks. We also find higher (lower) imbalanced trading, information flow, and price efficiency associated with market-wide (firm-specific) news during the pandemic.

Intangible Capital and Market Reactions to Earnings News*

AbstractWe investigate how market reactions to earnings news differ between U.S. firms with high and low intangible capital. We expect investors to have difficulty processing information on earnings news for firms with high intangible capital, leading to a larger reaction to earnings news. Measuring intangible capital as the accumulated sum of externally purchased and internally created intangible assets, we show that both immediate and delayed market reactions to earnings news are larger for high‐intangible firms. Multivariate regressions and four‐factor alphas support the results. This effect is more substantial for firms with limited investor attention and mainly driven by organization capital.

Firm centrality and limited attention

This study examines whether investor attention towards stocks is related to firm centrality in the input-output network. Using a data set of firms’ principal customers, we investigate the effect of firm centrality on the stock return predictability across economically linked firms. We find that stock prices do not promptly incorporate news about principal customers, generating return predictability which diminishes with the customer firm centrality levels. We show that this result is driven by limited investor attention. The evidence reveals that customer firms occupying more central positions in the network receive more investor attention. The results remain strong even when we make use of size-adjusted centrality values, indicating that the centrality effect is not driven by firm size. We find that more central firms are associated with greater financial analyst coverage and greater institutional investor equity holdings. Moreover, our analyses explicate that the source of information has an important role in attracting investor attention.

How investor attention affects stock returns? Some international evidence

We examine the effects of limited investor attention on stock returns by using Google search volume index to measure investor attention. We also investigate whether national culture and market development have any role in this relationship. We find that the impact of investor attention on stock returns is not consistent throughout the world. The direction and significance of the impact vary from country to country. We also find that investor attention is more significant in individualistic countries, countries with high uncertainty avoidance, and developed countries. Furthermore, we find that the impact of abnormal returns on investor attention is more consistent across countries. One-week lagged absolute abnormal returns can positively predict investor attention in sixteen countries. Our results also show that investor attention returns to normal levels in three weeks in individualistic countries and countries with low uncertainty avoidance.

Communications in proxy contests

This paper studies the communication of “voice” in shareholder activism. Using hand-collected data, I investigate how the use of investor presentations, among other communication strategies, affects the outcomes of proxy contests. Being the first to make presentations to investors increases the dissident's chance of winning by 60%. To understand this first-mover advantage, I examine the allocation of investor attention and variation in investor sophistication. The evidence is consistent with an explanation of limited investor attention. The findings highlight the role of communication in corporate governance.

Investor Attention from Internet Search Volume and Underreaction to Earnings Announcements in Korea

Recent studies have used internet search volume as a measure of investor attention. In addition, literature argues that limited investor attention contributes to market underreaction to public information such as earnings announcements. We show that firms with more investor attention captured by abnormal internet search frequency have stronger announcement-day reactions and weaker post-earnings-announcement drift. The effect of abnormal search frequency is stronger for medium and small-sized firms, which usually receive insufficient attention. Our evidence indicates that firms with higher search intensity are traded more, especially by individual investors. Moreover, we imply that it is a sustainable development for investors to be able to use public information through the internet for investment in stock markets.

Implied Cost of Capital and Mutual Fund Performance

This study provides evidence for a positive association between mutual fund holdings' implied cost of capital (ICC) and future performance. Consistent with large transaction costs of ICC-based investments impeding their exploitation and employing a ICC-based strategy reflecting skill, family-level trading efficiency and manager-level SAT score positively correlate with fund-level ICC. A negative association between ICC and mid-year risk shifting corroborates the notion of fund managers decisively choosing and relying on high-ICC strategies. Institutional investors able to identify funds with high ICC direct their investments accordingly, whereas flows of retail funds are unaffected, consistent with limited investor attention and financial literacy.

Market reaction to regulatory policy changes in financial statements filings: evidence from Turkey

Financial reporting has a vital impact on investors for acquiring and integrating value-relevant information in making or revising investment decisions. This article investigates how changes in regulatory disclosure policy for financial reporting influence market reaction for the companies listed on Borsa Istanbul over the period 2003–2017. We elaborate our findings in the context of investor attention and trading opportunities, resulting in three distinct policies. The results reveal that small-cap firms are more exposed to abnormalities than large-cap firms for positive news before and after the public disclosure platform (PDP). Further, the number of financial statements filings made on the same day affects the abnormal returns before the PDP (from 2003 to June 2009) and, after the PDP (from 2009 to 2013), where the companies are allowed to release them intra-day. Additionally, the response of investors to financial statements filings on Friday is quite different than other days of the week before the PDP and after the PDP (from 2013 to 2017), where the companies are required to make their release only after the market closure. Finally, as a search-facilitating technology, the adaptation of eXtensible Business Reporting Language (XBRL) does not translate into an improvement on market reaction. These findings support the validation of limited investor attention and post-announcement drift in the Turkish capital market.

Mispricing or Risk Premium? An Explanation of the R&D-to-Market Anomaly

Two contrasting explanations are offered in the literature for the R&D-to-market anomaly: mispricing of R&D resulting from limited investor attention to R&D spending, and the failure of conventional risk factors to completely capture the risk associated with R&D. Exploiting accounting treatments in Korea, in which R&D expenditures are capitalized under certain conditions, we show that the positive R&D-returns relationship weakens as an R&D project approaches completion, a finding that is consistent with Berk, Green, and Naik's (2004) risk-based theoretical prediction. This decrease in returns following progress toward R&D completion is fully explained by conventional risk factors, a finding that is inconsistent with mispricing of R&D. Furthermore, both the expensed and capitalized portions of R&D are positively associated with returns, suggesting that conservative accounting treatments cannot explain the anomaly. The results suggest overall that the R&D-to-market anomaly is attributable to compensation for bearing risk.

Blaze New Trails for Others to Follow: Evidence from Scanner Data

Tracking more than 100 billion weekly transactions of two million products at the barcode level from 2007 to 2017, we identify and categorize new products as pioneers, followers and improvers to study corporate exploratory and/or exploitative innovation strategies. Firms introducing “pioneer” products are associated with greater future profitability and stock returns than those introducing “improver” and “follower” products. Price elasticity of demand explains pioneering (exploratory) innovation’s operating success. Meanwhile, limited investor attention accounts for pioneering firms’ superior stock performance. We exploit two exogenous shocks to firms’ new product development decisions to address endogeneity concerns.

Communications in Proxy Contests

This paper studies the communication of “voice” in shareholder activism. Using hand-collected data, I investigate how the use of investor presentations, among other communication strategies, affects the outcomes of proxy contests. Being the first to make presentations to investors increases the dissident’s chance of winning by 60 percent. To understand this first-mover advantage, I examine the allocation of investor attention and variation in investor sophistication. The evidence is consistent with an explanation of limited investor attention. The findings highlight the role of communication in corporate governance.

Shared analyst coverage: Unifying momentum spillover effects

Identifying firm connections by shared analyst coverage, we find that a connected-firm (CF) momentum factor generates a monthly alpha of 1.68% (t = 9.67). In spanning regressions, the alphas of industry, geographic, customer, customer/supplier industry, single- to multi-segment, and technology momentum factors are insignificant/negative after controlling for CF momentum. Similar results hold in cross-sectional regressions and in developed international markets. Sell-side analysts incorporate news about linked firms sluggishly. These effects are stronger for complex and indirect linkages. Consistent with limited investor attention, these results indicate that momentum spillover effects are a unified phenomenon that is captured by shared analyst coverage.

Mispricing or the Risk Premium? An Explanation of the Positive R&D-Stock Return Relationship

Two contrasting explanations are offered in the literature for the R&D-to-market anomaly: limited investor attention to R&D spending that is expensed under generally accepted accounting principles or failure of conventional risk factors to completely capture the risk associated with R&D. Exploiting accounting treatments in Korea, in which R&D expenditures are capitalized under certain conditions, we show that both the expensed and capitalized portions of R&D are positively associated with returns. The positive R&D-return relationship weakens with the extent of progress toward completion of R&D projects, consistent with Berk, Green, and Naik's (2004) risk-based theoretical prediction. In addition, the decrease in returns following progress toward R&D completion is fully explained by conventional risk factors. The results suggest overall that the positive R&D-return relationship is attributable to compensation for bearing risk.

Limited investor attention, relative fundamental strength, and the cross-section of stock returns

We explore the underlying reasons for the apparent mispricing of firms based on fundamental information. We document that a relative fundamental strength strategy that buys (sells) firms with strong (weak) fundamentals is highly profitable for up to three years. The results cannot be explained by either price or earnings momentum, are robust to risk adjustments based on standard asset pricing models, and survive a battery of robustness tests. The strategy also works better among small firms, as well as firms with low analyst coverage and a high probability of informed trading. Our empirical findings support the hypotheses of limited investor attention and informed trading.

Shared Analyst Coverage: Unifying Momentum Spillover Effects (Internet Appendix)

Full paper is available at: https://ssrn.com/abstract=3015582 Identifying firm connections by shared analyst coverage, we find that a connected-firm (CF) momentum factor generates a monthly alpha of 1.68% (t = 9.67). In spanning regressions, the alphas of industry, geographic, customer, customer/supplier industry, single- to multi-segment, and technology momentum factors are insignificant/negative after controlling for CF momentum. Similar results hold in cross-sectional regressions and in developed international markets. Sell-side analysts incorporate news about linked firms sluggishly. These effects are stronger for complex and indirect linkages. Consistent with limited investor attention, these results indicate that momentum spillover effects are a unified phenomenon that is captured by shared analyst coverage.