Does Earnings Quality Affect Information Asymmetry: Evidence from Trading Costs

Information asymmetry in financial markets relates to the idea that one party to a transaction has better information than the other. Since financial reporting involves the transmission of value relevant enterprise information, we investigate whether the quality of reported earnings can contribute to differentially informed financial market participants. Higher information asymmetry is costly as it increases the adverse selection risk for market participants and lowers liquidity. For a large sample of NYSE and NASDAQ firms, we show that (i) poor earnings quality is significantly and incrementally associated with higher information asymmetry, (ii) earnings quality disproportionately affects information asymmetry for firms with poor information environments, (iii) both innate and discretionary components of earnings quality increase information asymmetry, and (iv) poor earnings quality exacerbates the information asymmetry around earnings announcements. Our results suggest that the standard setters’ efforts to develop accounting standards that improve earnings quality should contribute to a better information environment for market participants and increase stock liquidity

Long-Run Common Stock Returns Following Stock Splits and Stock Dividends

We examine one-to three-year performance of common stocks following stock split and stock dividend announcements made during the period 1976 to 1991. The average one-and three-year buy-and-hold abnormal returns after the announcement month are 8.19% and 7.55% respectively. Also, smaller firms exhibit larger announcement period as well as larger one-to three-year abnormal returns. The results cannot be explained away by general cash-dividend increase announcements or earnings announcements. Overall, the results are consistent with the hypothesis that the market underreacts to the stock split and the stock dividend announcements

Long-Run Common Stock Returns Following Stock Splits and Reverse Splits

We examine one- to three-year performance of common stocks following 5596 stock split and 76 reverse split announcements made during the period 1976 to 1991. For stock splits, on average, the one- and three-year buy-and- hold abnormal after the announcement month are 7.05% and 11.87%, respectively. For reverse splits, the corresponding abnormal returns are - 10.76% and -33.90%. The results suggest that the market underreacts to both the stock split and the reverse split announcements. We also provide evidence that the signal in stock splits is related to change in dividends. In particular, the announcement period and the long-run abnormal returns are both positively associated with an increase in dividends.

An Analysis of the Recommendations of the Superstar Money Managers at Barron\u27s Annual Roundtable

We examine the performance of common stock recommendations made by prominent money managers at Barron\u27s Annual Roundtable from 1968 to 1991. To avoid survivorship bias, we examine the performance of recommendations by all the participants. The buy recommendations earn significant abnormal returns of 1.91% from the recommendation day to the publication day, a period of about 14 days. However, the abnormal returns are essentially zero for one to three year post-publication day holding periods. Thus, an individual investing according to the Roundtable recommendations published in Barron\u27s would not benefit from the advice

Long-Run Stock Returns Following Briloff\u27s Analyses

Abraham Briloff is well known for more than four decades of insightful analysis and criticism of the accounting practices of various companies. His critiques, in the form of articles published in Barron\u27s, consist of detailed financial analyses of the questionable accounting practices of the companies he examines. Previous research has shown that the companies criticized by Briloff in Barron\u27s experience significant negative abnormal returns around the article\u27s publication date. To understand the valuation effect associated with his financial analyses, this article examines long-run abnormal returns following the publication date. In addition to the initial negative reaction on publication of the articles, the companies in the sample experienced further significant risk-adjusted returns for one and two years of, respectively, -15.51 percent and -22.88 percent. The results show that a decline in future operating performance appears to be an important reason for the poor stock market performance of the companies. Thus, Briloff could apparently foresee the coming decline in operating performance better than the market could. These results underscore the importance of understanding a company\u27s accounting and of the role of careful financial statement analysis

Long-Run Stock Returns Following Briloff\u27s Analyses

Abraham Briloff is well known for more than four decades of insightful analysis and criticism of the accounting practices of various companies. His critiques, in the form of articles published in Barron\u27s, consist of detailed financial analyses of the questionable accounting practices of the companies he examines. Previous research has shown that the companies criticized by Briloff in Barron\u27s experience significant negative abnormal returns around the article\u27s publication date. To understand the valuation effect associated with his financial analyses, this article examines long-run abnormal returns following the publication date. In addition to the initial negative reaction on publication of the articles, the companies in the sample experienced further significant risk-adjusted returns for one and two years of, respectively, -15.51 percent and -22.88 percent. The results show that a decline in future operating performance appears to be an important reason for the poor stock market performance of the companies. Thus, Briloff could apparently foresee the coming decline in operating performance better than the market could. These results underscore the importance of understanding a company\u27s accounting and of the role of careful financial statement analysis

On Distinguishing Between Valuation and Arbitrage Motivated Short Selling

The short interest data reported in the United States aggregate valuation shorts (motivated by a pessimistic opinion on firm value) and arbitrage shorts (motivated by various arbitrage or hedging strategies). However, the information content of these two sources of short interest is different and hence their association with future returns is expected to be different. In recent years, the association between short interest and future returns has weakened considerably, reflecting the increasing importance of institutions that execute arbitrage strategies. The primary contribution of this study is an empirical model that ex-ante helps differentiate valuation shorts from arbitrage shorts. In out-of-sample tests, we document that, consistent with theoretical predictions, the firms identified by the model as valuation shorts exhibit high short interest and poor future returns. Furthermore, firms identified as arbitrage shorts do not exhibit significant negative returns but instead exhibit characteristics associated with arbitrage strategies. The paper also identifies variables that are correlated with the information set of short sellers. We present an application that exploits the model\u27s ability to ex-ante identify poor performers and discuss broader applications in other finance settings

An Analysis of the Recommendations of the "Superstar" Money Managers at Barron's Annual Roundtable.

The authors examine the performance of common stock recommendations made by prominent money managers at Barron's Annual Roundtable from 1968 to 1991. To avoid survivorship bias, they examine the performance of recommendations by all the participants. The buy recommendations earn significant abnormal returns of 1.91 percent from the recommendation day to the publication day, a period of about fourteen days. However, the abnormal returns are essentially zero for one to three year postpublication day holding periods. Thus, an individual investing according to the Roundtable recommendations published in in Barron's would not benefit from the advice. Copyright 1995 by American Finance Association.

Earnings Quality and Information Asymmetry: Evidence from Trading Costs

The adverse consequences of poor earnings quality have been the subject of significant debate among academics, practitioners and regulators. However, the empirical evidence on pricing implications of earnings quality is sparse and controversial. We examine one potential consequence of poor earnings quality - its impact on information asymmetry. We document that poor earnings quality increases the adverse selection risk as manifested in trading costs and lowers liquidity in financial markets. Both innate and discretionary components of earnings quality contribute significantly to information asymmetry. Further, poor earnings quality exacerbates information asymmetry around earnings announcements, especially for firms where earnings represent the principal source of information for market participants, suggesting that poor quality earnings offers a greater information advantage to informed traders. An important implication is that earnings quality can affect cost of capital via its impact on trading cost. Additionally, from a policy perspective, we show that earnings quality can lead to significant variation in information asymmetry even for firms within a uniform reporting regime