Low Analyst Research Articles

RegTech Adoption and the Cost of Capital

This paper studies the cost of capital effect of a major regulatory technology, or RegTech, event: the staggered implementation of the Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system of the Securities and Exchange Commission in the period from 1993 to 1996. This event represents a largely exogenous shock to corporate information dissemination technologies, resulting in a considerable reduction in information acquisition costs for investors. Using a difference-in-differences research design, we show that the cost of equity capital declines substantially after a firm switches from paper filing to mandatory electronic filing in EDGAR. The effect is stronger for small firms and firms with low analyst coverage and low institutional ownership. We identify three channels through which EDGAR affects a firm’s cost of capital: the liquidity, risk-taking, and corporate governance channels. EDGAR implementation also improves a firm’s investment efficiency significantly. We find evidence that the marginal value of a firm’s capital investment and cash is higher during the post-EDGAR period. This paper was accepted by Suraj Srinivasan, accounting. Funding: C. Lin acknowledges financial support from the National Science Foundation of China [Grant 72192841] and the Research Grants Council of the Hong Kong Special Administration Region, China [Project HKU R7054-18 and T35/710/20R]. S. Lai acknowledges financial support from the Ministry of Science and Technology, Taiwan [Grants 107-2410-H-002-038-MY3 and 110-2410-H-002-079-MY2] and the E. Sun Academic Award. X. Ma acknowledges research support from the University of Macau [Grants SRG2019-00158-FBA and MYRG2020-00259-FBA]. Supplemental Material: Data are available at https://doi.org/10.1287/mnsc.2022.4660 .

Shaping the Information Environment: International Evidence on Financial Reporting Frequency and Analysts’ Earnings Forecast Errors

This article investigates the role of mandatory interim financial reporting in financial analysts’ annual earnings forecast errors. We provide large-scale evidence from 49 countries that a mandatory quarterly (as compared to semi-annual) reporting regime is associated with lower analysts’ annual earnings forecast errors. This conjecture is further supported when we exploit an exogeneous change in the mandatory frequency regime from a semi-annual to a quarterly reporting mandate in Japan. Consistent with an improvement in the information environment, our findings are more pronounced for firms and analysts subject to higher information acquisition costs and in countries where the institutional setting is less able to meet analysts’ information needs. We corroborate this conjecture by documenting that more frequent mandatory reporting decreases analysts’ forecast dispersion and improves the profitability of their stock recommendations. Overall, our findings extend the research on the role of the institutional setting in analysts’ output, suggesting that the mandate of more frequent reporting improves analysts’ forecasting process.

Oil price uncertainty and stock price informativeness: Evidence from investment-price sensitivity in China

We study the effects of oil price uncertainty (OPU) on stock price informativeness based on investment-price sensitivity. Using Chinese stocks from 2008 to 2021, we find a negative relationship between OPU and the strength of Tobin's q (a standardized measure of prices) for predicting investment opportunities. This finding is likely due to the crowding out of informed investors rather than the financial constraints brought by a higher cost of capital. Investment-price sensitivity also decreases more among firms in less-competition, high sales volatility, and lower analysts' attention. What is more, the reduction in investment-price sensitivity is more concentrated in public utilities, agriculture & livestock, and industry instead of in real estate or commerce industries. These findings indicate that OPU decreases the acquisition of information related to firms, and consequently, price informativeness for future investment decisions.

Shifting from the incurred to the expected credit loss model and stock price crash risk

Using a difference-in-differences (DID) design, this study examines the effect of shifting from the incurred credit loss model (ICL model) to the expected credit loss model (ECL model) on banks’ future stock price crash risk. We find that switching to the ECL model decreases the stock price crash risk of commercial banks. Inspired by Onali et al. (2021), we proceed with cross-sectional tests from the perspectives of opportunistic incentives, information environments, and compliance costs and find that the effect is more pronounced for (i) banks with less opportunistic incentives, proxied by state-owned property rights and managerial ownership; (ii) banks with opaque internal and external information environments, proxied by weak internal control, weak board governance, low analyst coverage, and short auditor tenure; and (iii) banks with lower implementation costs, proxied by less day-one impact and higher levels of accounting conservatism. Channel analyses show that banks increase their asset impairment provisions and the timeliness of loan loss recognition, and there is an increase in the value relevance of earnings and bank efficiency after the adoption of the ECL model. Overall, our evidence suggests that the flexibility of principle-based accounting standards influences banks’ stock price crash risk and provides implications that could be helpful to regulators and standard setters.

The impact of analyst forecast errors on fundamental indexation: the Australian evidence

Evidence from many developed markets suggests that fundamental indices outperform capitalisation-weighted indices. Existing studies suspect a story of market mispricing, yet a mechanism has not been identified. Using Australian data, we study the relation between analyst forecast errors and the performance of various fundamental indices. We find that fundamental indices contain a relatively higher exposure to stocks with low analyst long-term growth forecasts. Valuations for these stocks are ex ante overly pessimistic and drive the statistical significance of alphas produced by fundamental indexation. We show how hedging against analyst forecast errors can generate additional alpha for investors using fundamental indexation.

Firms' digitalization and stock price crash risk

Effects of digital transformation on value creation, productivity, and innovation have been previously examined. However, only a few studies have explored how the capital market responds to firms' digitalization, and the relationship between digital transformation and stock price crash risk has remained unknown. The current study explores this gap by using data of listed firms in China in 2007–2020. We create a Chinese dictionary containing digital keywords by using the deep learning model, and set the proportion of intangible assets related to digital keywords as proxy for digital transformation. Findings show that digital transformation significantly reduces stock price crash risk. Moreover, results remain robust after addressing endogeneity problems and several robustness tests. Heterogeneity analysis suggests that the attenuation effect of digital transformation on stock price crash risk is strong for firms that are small, with low analyst attention, in the tech industries, and in areas with high trust. This study validates two potential mechanisms, namely, information and internal control channels. Lastly, digital transformation significantly reduces opacity and increases internal control quality.

Investors' responses to macroeconomic news: the role of mandatory derivatives and hedging activities disclosure

Purpose The purpose of this study is to investigate how changes in the firm's information disclosure practices impact the way investors process macroeconomic news. Specifically, the authors examine the role of derivative instruments and hedging activities disclosure, as required by SFAS 133, in shaping invertors response to good and bad interest rate news. In addition, the authors examine whether the effect of SFAS 133 on investors' response to good and bad interest rate news varies between firms with higher and lower earnings volatility.Design/methodology/approach This study uses data on all US public firms over the period from 1990 to 2019. The authors mainly apply multivariate regression and a difference-in-difference approach to test their hypotheses.Findings The results show a significant decrease in the asymmetry of responses to good and bad interest rate news for users of interest rate derivatives following the adoption of SFAS 133. However, in contrast to this finding, the authors also find that the adoption of SFAS 133 has no impact on the asymmetry of responses to good and bad interest rate news for nonusers of interest rate derivatives. Consistent with the ambiguity theory, the finding suggests that SFAS 133 indeed decreases investors’ uncertainty (ambiguity) about the cash flow implications of changes in the interest rate. The authors also find that the decrease in the asymmetry of response to good and bad interest rate news after the adoption of SFAS 133 is greater for users of interest rate derivatives with higher than lower earnings volatility. This implies that derivatives and hedging activities disclosure, as required by SFAS 133, are more important for firms with higher than lower earnings volatility. The finding is consistent with the idea that investors demand more accounting information when underlying earnings volatility is higher. In a set of additional analyses, the authors find that the effect of SFAS 133 on investors' response to good and bad interest rate news varies depending on the level of analyst coverage and interest rate exposure. Specifically, the authors find that the decrease in the asymmetry of response to good and bad interest rate news after the adoption of SFAS 133 is greater for users of interest rate derivatives with higher interest rate exposure and lower analyst coverage.Practical implications The findings of this study help market participants including regulators and standard setters to understand the impact of mandatory disclosure practices on investors' reaction to macroeconomic news. Moreover, the findings of the study help managers to understand the influence firm-specific characteristics (e.g. earnings volatility, analyst coverage and interest rates exposure) on the effectiveness of mandatory derivative instruments and hedging activities disclosure.Originality/value To the best of the authors' knowledge, this is the first paper to explore how firm-specific information environment affects the way investors process macroeconomic news. This study contributes to the literature by providing the empirical evidence that derivatives instruments and hedging activities, as required by SFAS 133, affect investors' response to good and bad interest rate news. In doing so, the results provide insights about how firm-specific information environment affects the way investors process macroeconomic news. This study shows that the cross-sectional variation in earnings volatility, analysts’ coverage and interest rate exposure affects the impact of SFAS 133 on investors' response to good and bad interest rate news. The findings are not only the notable addition to the existing literature on the topic but also can aid to market participants including policy makers, regulators, standard setters and managers to understand the influence of firm-specific characteristics on the effectiveness of mandatory derivative instruments and hedging activities disclosure. Finally, the findings contribute to the general debate about the effectiveness of SFAS 133 by showing that the adoption of SFAS 133 indeed decreases information ambiguity.

Capital Market Liberalization and Investment Efficiency: Evidence from China

For this study, we adopted a recent financial reform in China and used a difference-in-difference model to investigate its impact on corporate investment efficiency. The results indicate that stock market liberalization has significantly improved corporate investment efficiency, primarily by restraining overinvestment. This effect exists chiefly in enterprises without former foreign ownership, those with low analyst coverage, and those that are privately owned. Further analysis reveals that improvements in corporate information disclosure and the corporate governance level are important transmission channels for improved efficiency. This study enriches research on the economic consequences of capital market liberalization and foreign investors’ governance channels, thereby providing implications for governments.

The Earnings Expectations Game and the Dispersion Anomaly

This study examines the role of differences in firms’ propensity to meet earnings expectations in explaining why firms with high analyst forecast dispersion experience relatively low future stock returns. We first demonstrate that the negative relation between dispersion and returns is concentrated around earnings announcements. Next, we show that this relation disappears when we control for ex ante measures of firms’ propensity to meet earnings expectations and that the component of dispersion explained by these measures drives the return predictability of dispersion. We further demonstrate that firms with low analyst dispersion are substantially more likely to achieve positive earnings surprises and provide new evidence consistent with both expectations management and strategic forecast pessimism explaining this result. Overall, we conclude that investor mispricing of firms’ participation in the earnings-expectations game provides a viable explanation for the dispersion anomaly. This paper was accepted by Brian Bushee, accounting.

Feedback loops in industry trade networks and the term structure of momentum profits

Industries are economically linked through customer-supplier trade flows. We show that industry shocks propagating along this intersectoral trade network can feed back to the originating industry, causing an “echo”–intermediate-term autocorrelation in returns. Adopting techniques from graph theory, we find that the strength of the trade network feedback is a crucial determinant of the echo effect in industry returns. Returns of the echo strategy implemented within high-feedback strength industries reach 1% monthly. Consistent with limited-information models, the relation between feedback strength and echo profits is strongest in industries with information diffusion frictions, such as low analyst coverage, along the feedback loop. Overall, our results identify intersectoral trade networks as important conduits of industry shocks and provide the first explanation for the echo effect.

Air pollution and initial public offering underpricing

ABSTRACT We examine the impact of air pollution in a city in which an initial public offering (IPO) firm is located to its IPO underpricing. Our findings suggest that when air pollution is severe, the IPO underpricing is high. The results are robust to alternative metrics of air pollution and IPO underpricing, an instrumental variable approach, and a difference-in-differences research design. Additional analyses suggest that (1) seasoned firms located in severe air pollution cities have high crash risk, (2) seasoned firms located in severe air pollution cities have tightened financial constraints and makes more environmental investment, (3) IPO firms in severe air pollution cities have less analyst and institutional investor site visits. These findings support the underlying logic that air pollution worsens a firm’s information environment and financial constraint. We also find that the effect is more salient for IPOs with low analyst following, low institutional investor site visits, and high earnings management, corroborating the information asymmetry explanation of underpricing. Therefore, addressing environmental issues is important to public health as well as to capital formation.

Regional GDP Distortion and Analyst Forecast Accuracy: Evidence from China

The reliability of China’s GDP data has been questioned for a long time. Prior studies have discussed the causes of GDP distortion in China, but the evidence on the economic consequences is scant. This paper examines the economic consequences of regional GDP distortion from the perspective of analyst forecasts. We find that regional GDP distortion leads to lower analyst forecast accuracy, and this result is robust to potential endogeneity. Further investigations show that analysts with information advantages have the ability to resist the distorted GDP data and issue accurate forecasts. Political pressure is another factor leading to inaccurate analyst forecasts. Our paper contributes to the literature by highlighting the importance of the reliability of GDP figures as a determinant of analyst forecast accuracy.

How does the Reform of Social Insurance System Affect Corporate Tax Avoidance? Evidence from a Quasi-natural Experiment of the Transfer of Department in Social Insurance Contributions

As an important reform of social insurance system, the transfer of department in social insurance contributions has a wide and far-reaching impact on both the protection of workers’ rights and enterprises. In 2018, Plan for Deepening the Reform of Party and State Institutions, which was deliberated and adopted at the Third Plenary Session of the 19th CPC Central Committee, pointed out that in order to improve the collection and management efficiency of social insurance funds, the basic endowment insurance, basic medical insurance, unemployment insurance and other social insurance will be uniformly and fully collected by the tax department （the transfer of department in social insurance contributions）. It is proposed to plug the loopholes of social security payment through reform in accordance with the law, so as to make the social security fund grow sustainably, and regulate the social security payment behavior and related financial behavior of enterprises. However, the existing research on the micro enterprise economic consequences of the transfer of department in social insurance contributions is extremely scarce, which only involves the enterprise value and cost markup ratio of enterprises. This paper attempts to analyze the governance effect of the transfer of department in social insurance contributions from the perspective of tax avoidance and take the listed companies of China’s A-share from 2008 to 2018 as the initial sample for empirical test. The research finds that: The degree of tax avoidance is reduced after social insurance contributions are uniformly and fully collected by the tax department. The specific examination of the impact mechanism shows that, after the transfer of department in social insurance contributions, the tax department can master more financial information of enterprises and check their financial accounts through tax collection and audit, which improves the transparency of accounting information, and then restrains enterprise tax avoidance. Further study finds that the governance effect of the transfer of department in social insurance contributions on corporate tax avoidance is only reflected in the enterprises with weak tax collection and management, low audit quality and low analyst attention. From the new perspective of enterprise tax avoidance, this paper understands the governance effect of the transfer of department in social insurance contributions on enterprise financial behavior, enriches the literature on the impact of the transfer of department in social insurance contributions on micro enterprise behavior. The findings are helpful for policymakers to clarify the potential impact of the reform of the transfer of department in social insurance contributions on enterprises, and have policy implications for the government to further optimize social security system.

Hedge funds and their prime broker analysts

Are sell-side analysts reluctant to go against the investment views of their hedge funds when these hedge funds are their prime brokerage clients? We show that prime broker analysts tend to upgrade stocks recently bought by their clients. For stocks with upgraded recommendations, post-announcement cumulative abnormal returns are significantly lower for those purchased by the prime brokerage clients. Our results are stronger with high-dollar-turnover clients who generate more trading commissions. We also find that a hedge fund with a large bet on a stock has a stronger incentive to pressure the fund’s prime brokers to issue a favorable recommendation on the stock. Results are not driven by stocks of firms with low analyst coverage or small size.

Demand for Idiosyncratic Lottery-like Payoffs and the Cross-section of Expected Returns

Motivated by existing evidence of a preference among investors for stocks with high maximum daily returns, we document that lottery-like payoffs measured by maximum daily returns are almost entirely idiosyncratic. Firm-level cross-sectional regressions and portfolio-sort analyses prove that there is a significantly negative relation between idiosyncratic maximum daily returns (IMAX) and future stock returns. While beta anomaly, negative (positive) risk-adjusted returns generated by high (low) market beta stocks, disappears when portfolios are constructed to be neutral to idiosyncratic maximum daily returns, the significantly negative return spread between the stocks with extreme idiosyncratic lottery-like payoffs are robust to various firm-specific controls and risk factors. Investor sentiment is the dominant factor to trigger the demand for stocks with high idiosyncratic lottery-like payoffs. Finally, the relationship between idiosyncratic maximum daily returns and subsequent returns is stronger among stocks with low institutional ownership, low market capitalization, low analyst coverage, low liquidity, and high idiosyncratic volatility.

The Earnings Expectations Game and the Dispersion Anomaly

This study examines the role of differences in firms' propensity to meet earnings expectations in explaining why firms with high analyst forecast dispersion experience relatively low future stock returns. We first demonstrate that the negative relation between dispersion and returns is concentrated around earnings announcements. Next, we show that this relation disappears when we control for ex-ante measures of firms' propensity to meet earnings expectations and that the component of dispersion explained by these measures drives the return predictability of dispersion. We further demonstrate that firms with low analyst dispersion are substantially more likely to achieve positive earnings surprises, and provide new evidence consistent with both expectations management and strategic forecast pessimism explaining this result. Overall, we conclude that investor mispricing of firms' participation in the earnings expectations game provides a viable explanation for the dispersion anomaly.

Does More Effective Director Monitoring Make Management Guidance More Credible?

Evidence of the impact of governance on disclosure credibility is inconclusive. Based on a large, post-Regulation Fair Disclosure (Reg-FD) sample, we find that increased director monitoring – through increased director independence and director attention – is associated with more credible management guidance, as evidenced by stronger analyst reactions to the news in management guidance. We document additional cross-sectional differences in the monitoring/credibility link, consistent with monitoring being particularly impactful when the role of external verification is largest (good news forecasts, low analyst following). We are able to identify causal effects through exogenous shocks to monitoring associated with (1) director deaths, (2) mandated independence required by Sarbanes-Oxley (SOX), and (3) changes in director attention due to M&A activities that eliminate board positions at other firms. This finding does not appear to be due to a link between effective monitoring and more accurate guidance, as the stronger analyst reactions occur only when guidance is less accurate. Overall, our findings provide strong support for director monitoring influencing the perceived credibility of management forecasts, especially in settings where external validation is needed.

Institutional investor distraction and earnings management

In this study, we explore the implications of institutional investor distraction for earnings management. Our identification approach relies on a firm-level measure of institutional investor distraction that exploits exogenous attention-grabbing shocks to unrelated parts of institutional investors' portfolios. We find that firms with distracted institutional shareholders engage more in both accrual-based and real earnings management. Further analyses show that the association between investor distraction and earnings management is stronger in firms with low analyst coverage and weak board monitoring, as well as in firms where managing earnings upward allows meeting or just beating their earnings target. Collectively, our results suggest that managers exploit the loosening in monitoring intensity resulting from investor distraction by engaging in earnings management. Even in the presence of institutional investors with superior monitoring abilities, limited attention may induce insufficient monitoring of earnings management practices.

Public Disclosure of Private Meetings: Does Transparency of Corporate Site Visits Affect Analysts’ Attention Allocation?

We investigate the impact of observing peers’ information acquisition on financial analysts’ attention allocation. Using the timely disclosure mandate by the Shenzhen Stock Exchange as a setting, we find that, when analysts can observe that a firm is visited by other analysts, they allocate less attention to it. This finding is consistent with the conjecture that the timely disclosure reveals the relative information advantage of visiting analysts, leading nonvisiting analysts to reallocate their attention. Further evidence suggests that the timely disclosure has positive externalities in the form of increased attention and improved informational efficiency for nonvisited peer firms, especially those with low analyst following.

Does corporate innovation strategy influence stock price crash risk? French market evidence

The purpose of this paper is to examine the effect of corporate innovation strategy on firm-level stock price crash risk. Using a sample of French listed firms covering 2007–2016, we show that innovative firms are more prone to future stock price crash risk. Managers of these firms have optimistic expectations about growth prospects that encourage them to hide bad news, leading to higher stock price crash risk. This positive relationship is only prevalent in competitive product markets and with low analyst coverage suggesting that innovative firms are likely to experience stock price crashes when information asymmetry is exacerbated. Our results stand up to several robustness tests and remain unchanged after addressing endogeneity concerns.