Tag: Market reaction

Prices and Informed Trading

Vyacheslav Fos is Assistant Professor of Finance at Boston College. This post is based on an article by Professor Fos and Pierre Collin-Dufresne, Professor of Finance at the Swiss Finance Institute. Related research from the Program on Corporate Governance includes Pre-Disclosure Accumulations by Activist Investors: Evidence and Policy by Lucian Bebchuk, Alon Brav, Robert J. Jackson Jr., and Wei Jiang; and The Law and Economics of Blockholder Disclosure by Lucian Bebchuk and Robert J. Jackson Jr. (discussed on the Forum here).

In our paper, Do Prices Reveal the Presence of Informed Trading?, forthcoming in the Journal of Finance, we study how empirical measures of stock illiquidity and of adverse selection respond to informed trading by activist shareholders.

An extensive body of theory suggests that stock illiquidity, as measured by the bid-ask spread and by the price impact of trades, should be increasing in the information asymmetry between market participants. An extensive empirical literature employing these illiquidity measures thus assumes that they capture information asymmetry. But, do these empirical measures of adverse selection actually increase with information asymmetry? To test this question one would ideally separate informed from uninformed trades ex-ante and measure their relative impact on price changes. However, since we generally do not know the traders’ information sets, this is hard to do in practice.


Public Pension Funds’ Shareholder-Proposal Activism

James R. Copland is the director of the Manhattan Institute’s Center for Legal Policy. The following post is based on a report from the Proxy Monitor project; the complete publication, including footnotes, is available here.

America’s largest publicly traded companies are facing more shareholder proposals in 2015, driven principally by a “proxy access” campaign led by New York City Comptroller Scott Stringer, who oversees the city’s $160 billion pension funds for public employees. Elected in 2013, Stringer has launched a Boardroom Accountability Project seeking, in part, proxy access, which grants shareholders with a certain percentage of a company’s outstanding shares the right to list a certain number of candidates for the company’s board of directors on the company’s proxy statement. As noted in an earlier finding, Comptroller Stringer’s proxy-access campaign has won substantial shareholder support at most companies where his proposal was introduced.

Although it is too soon to assess the impact of Comptroller Stringer’s push for proxy access, we can evaluate shareholder-proposal activism by state and municipal public employee pension funds in previous years. From 2006 to the present, state and municipal pension funds have sponsored 300 shareholder proposals at Fortune 250 companies. More than two-thirds of these were introduced by the pension funds for the public employees of New York City and State.


Market (In)Attention and the Strategic Scheduling and Timing of Earnings Announcements

The following post comes to us from Ed deHaan of the Accounting Area at Stanford University; Terry Shevlin, Professor of Accounting at the University of California, Irvine; and Jake Thornock of the Department of Accounting at the University of Washington.

In our paper, Market (In)Attention and the Strategic Scheduling and Timing of Earnings Announcements, forthcoming in the Journal of Accounting and Economics, we revisit a long-standing but still unresolved question: do managers “hide” bad earnings news by announcing during periods of low market attention? Or, conversely: do managers “highlight” good earnings news by announcing earnings during periods of high market attention? We posit three necessary conditions for an effective hiding/highlighting strategy. First, to be able to hide bad news, managers must change their earnings announcement (“EA”) timing somewhat frequently. A deviation from a long-standing pattern of EA timing could attract attention to the very news the manager is trying to hide. Second, there must be variation in market attention that is predictable to the manager ex-ante—random variation in attention would not allow for strategic timing of bad or good news. Third, we must observe that managers do tend to announce more negative (positive) earnings news during periods of lower (higher) market attention. We also examine an additional potential strategy for reducing attention to bad news: by scheduling EAs with less advance notice or “lead-time.”


Are Companies Setting Challenging Target Incentive Goals?

The following post comes to us from Pay Governance LLC and is based on a Pay Governance memorandum by Ira Kay, Steve Friedman, Brian Lane, Blaine Martin, and Soren Meischeid.

Do companies set appropriately challenging goals in their incentive plans? How does a compensation committee determine whether management is recommending challenging goals? How important are earnings guidance and analyst expectations in goal setting? Are more challenging goals achieved as frequently as less challenging goals? How much are annual incentive payouts increased by the achievement of incentive goals? How does the stock market react to challenging goals?


Does Short Selling Discipline Earnings Manipulation?

The following post comes to us from Massimo Massa, Professor of Finance at INSEAD; Bohui Zhang of UNSW Business School, and Hong Zhang of the PBC School of Finance, Tsinghua University.

The experience of the recent financial crisis has brought to the attention the role of short selling. Short selling has been identified as a factor that contributes to market informational efficiency. At the same time, however, short selling has been regarded as “dangerous” to the stability of the financial markets and has been banned in many countries. Interestingly, these two seemingly conflicting views are based on the same traditional wisdom that short selling affects only the way in which information is incorporated into market prices by making the market reaction either more effective or overly sensitive to existing information but does not affect the behavior of firm managers, who may shape, if not generate, information in the first place.


Short Selling Pressure, Stock Price Behavior, and Management Forecast Precision

The following post comes to us from Yinghua Li of the School of Accountancy at Arizona State University and Liandong Zhang at City University of Hong Kong.

Corporate executives pay considerable attention to secondary market prices and they have strong incentives to maintain or increase the level of their firms’ stock prices. The accounting literature has long recognized that managers can make strategic financial reporting or disclosure choices to influence stock prices. A large body of empirical research examines whether and how corporate disclosures affect stock prices. The literature, however, provides little directional evidence on whether the behavior of stock prices has a causal effect on managerial strategic disclosure decisions. The difficulty in establishing causality stems largely from the endogenous nature of stock prices. In the paper, Short Selling Pressure, Stock Price Behavior, and Management Forecast Precision: Evidence from a Natural Experiment, which is forthcoming in Journal of Accounting Research, we use a randomized experiment, the Regulation SHO pilot program, to examine the causal effect of stock price behavior on managers’ voluntary disclosure choices.


Weather-Induced Mood, Institutional Investors, and Stock Returns

The following post comes to us from William Goetzmann, Professor of Finance at Yale University; Dasol Kim of the Department of Banking and Finance at Case Western Reserve University; Alok Kumar, Professor of Finance at the University of Miami; and Qin Wang of the Department of Accounting and Finance at the University of Michigan at Dearborn.

Studies showing that weather patterns in major financial centers influence stock index returns provide suggestive evidence that investor mood influences asset prices (Saunders, 1993; Hirshleifer and Shumway, 2003). Individuals may misattribute mood induced by weather as information when making assessments about objects that should be otherwise unrelated (Schwarz and Clore, 1983), leading to mood-congruent judgments. For example, sunnier days may induce good moods amongst investors, generating overly optimistic beliefs regarding their investments and congruently influencing their trading decisions. Despite strong evidence of the weather effect on stock index returns, establishing plausibility in mood-based explanations relies in part on distinguishing which group of investors drives the weather effect, and directly confirming mood effects in their judgments.


Measuring Price Impact with Investors’ Forward-Looking Information

The following post comes to us from Aaron Dolgoff and Tiago Duarte-Silva, both of Charles River Associates. The views expressed here do not necessarily reflect those of Charles River Associates.

The recent Supreme Court decision in Halliburton brought renewed interest to price impact and event studies. Aside from identification and analysis of the news itself, the event study has three basis steps: (i) Estimate a statistical model (or “market model”) of how the stock price would be expected to change in absence of such news (“predicted price changes”), (ii) Calculate stock price changes in excess of the predicted price changes (“excess price change”), and (iii) Evaluate the statistical significance of the excess price change to distinguish material news from noise, or normal variations in stock prices.


An IPO’s Impact on Rival Firms

The following post comes to us from Matthew Spiegel, Professor of Finance at Yale University, and Heather Tookes, Professor of Finance at Yale University.

An initial public offering (IPO) is a major event in the life of any firm. But what does an IPO imply for the industry’s future? In our paper, An IPO’s Impact on Rival Firms, which was recently made publicly available on SSRN, we take a structural approach that allows different industries to progress in different ways post IPO. If one is forced to make a sweeping generalization, then this paper finds an IPO augurs in an era of reduced profits and greater consumer mobility within an industry. Unlike a static model, a structural model’s parameters produce implications about magnitudes rather than just signs. This permits one to assess whether the estimates are economically “reasonable in a straightforward manner.”


Economic Crisis and Share Price Unpredictability: Reasons and Implications

The following post comes to us from Edward G. Fox of University of Michigan at Ann Arbor, Department of Economics, Merritt B. Fox, the Michael E. Patterson Professor of Law at Columbia Law School, and Ronald J. Gilson, Charles J. Meyers Professor of Law and Business at Stanford Law School.

During the recent financial crisis, there was a dramatic spike in “idiosyncratic volatility”—the volatility of individual firm share prices after adjustment for movements in the market as a whole. The average firm’s increase was a remarkable five-fold as measured by variance. This dramatic spike is not peculiar to the most recent crisis. Rather, it has occurred with each major downturn in the economy since the 1920s, as our paper shows for the first time. These spikes present a puzzle in terms of existing economic theory. They also have important implications for several areas of corporate and securities law where the capacity of securities prices to reflect available information is particularly important. Examples include the presumption of reliance, loss causation and materiality in fraud-on-the-market suits, materiality in insider trading cases, and the corporate law regulation of defenses undertaken by targets of hostile takeover attempts. The continuing centrality of these issues is underscored by this week’s decision in Halliburton Co v. Erica P. John Fund, where the Supreme Court ruled that a defendant can defeat a fraud-on-the-market case class certification by showing that the alleged misstatement had no impact on price.


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