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Abstract:
Prior literature observes that information uncertainty exacerbates investor underreaction behavior. In this paper, I investigate whether, as professional investment intermediaries, sell-side analysts suffer more behavioral biases in cases of greater information uncertainty. I show that greater information uncertainty predicts more positive (negative) forecast errors and subsequent forecast revisions following good (bad) news, which corroborates previous findings on the post-analyst-revision drift. The opposite effects of information uncertainty on forecast errors and subsequent forecast revisions following good vs. bad news support the analyst underreaction hypothesis and are inconsistent with analyst forecast rationality or optimism suggested in prior literature.

analyst forecasts error, forecast revision, information uncertainty, underreaction

Abstract:
Prior literature observes that information uncertainty exacerbates investor underreaction behavior. In this paper, I investigate whether, as professional investment intermediaries, sell-side analysts suffer more behavioral biases in cases of greater information uncertainty. I show that greater information uncertainty predicts more positive (negative) forecast errors and subsequent forecast revisions following good (bad) news, which corroborates previous findings on the post-analyst-revision drift. The opposite effects of information uncertainty on forecast errors and subsequent forecast revisions following good vs. bad news support the analyst underreaction hypothesis and are inconsistent with analyst forecast rationality or optimism suggested in prior literature.

Analyst forecasts error, forecast revision, information uncertainty, underreaction

Abstract:
This paper investigates two competing hypotheses for the accrual anomaly: investment/growth and persistence. Both investment/growth and persistence information in accruals are likely to vary cross-sectionally, depending on a firm's business model, a fact that generates different cross-sectional implications for the accrual anomaly. I find that the magnitude of the accrual anomaly monotonically increases with the investment information contained in accruals, as measured by the co-variation between accruals and employee growth. In industries/firms in which accruals co-vary with employee growth, accruals show strong predictive power for future stock returns. In industries/firms in which accruals show little correlations with employee growth, the accrual anomaly is much weaker. In contrast, the evidence from the cross-sectional analysis is inconsistent with the persistence argument. From the earnings perspective, the evidence on one-year-ahead earnings growth is inconclusive, but the results on longer-term earnings growth support the investment argument but not the persistence argument. Collectively, I conclude that these results support the view that the accrual anomaly is attributable to the fundamental investment information contained in accruals.

Accruals, investment, persistence, accrual anomaly, earnings management

Abstract:
This paper investigates two competing hypotheses for the accrual anomaly: investment/growth and persistence. Both investment/growth and persistence information in accruals are likely to vary cross-sectionally, depending on a firm's business model, a fact that generates different cross-sectional implications for the accrual anomaly. I find that the magnitude of the accrual anomaly monotonically increases with the investment information contained in accruals, as measured by the co-variation between accruals and employee growth. In industries/firms in which accruals co-vary with employee growth, accruals show strong predictive power for future stock returns. In industries/firms in which accruals show little correlations with employee growth, the accrual anomaly is much weaker. In contrast, the evidence from the cross-sectional analysis is inconsistent with the persistence argument. From the earnings perspective, the evidence on one-year-ahead earnings growth is inconclusive, but the results on longer-term earnings growth support the investment argument but not the persistence argument. Collectively, I conclude that these results support the view that the accrual anomaly is attributable to the fundamental investment information contained in accruals.

Accruals, investment, persistence, accrual anomaly, earnings management

Abstract:
There is substantial evidence of short-term stock price continuation, which the prior literature often attributes to investor behavioral biases such as underreaction to new information. This paper investigates the role of information uncertainty in price continuation anomalies and cross-sectional variations in stock returns. If short-term price continuation is due to investor behavioral biases, we should observe greater price drift when there is greater information uncertainty. As a result, greater information uncertainty should produce relatively higher expected returns following good news and relatively lower expected returns following bad news. My evidence supports this hypothesis.

Abstract:
There is substantial evidence of short-term stock price continuation, which prior literature often attributes to investor behavioral biases such as underreaction to new information. This paper investigates the role of information uncertainty in short-term CAPM anomalies and cross-sectional variations in stock returns. If short-term price continuation is due to investor behavioral biases, we should observe greater price drift when there is greater information uncertainty. As a result, greater information uncertainty produces relatively higher expected returns following good news and relatively lower expected returns following bad news. The evidence presented in this paper supports this hypothesis.

Information uncertainty, analyst forecast revision, momentum, expected returns

Abstract:
Prior studies find that (i) investors over-weight (or over-estimate the persistence of) past accruals and under-weight past cash flows, and (ii) analysts over-weight past accruals. We study financial analysts' and investors' assessments of the persistence of accruals and cash flows after explicitly controlling for the negative correlation between accruals and cash flows. We find that both analysts and investors under-weight past cash flows but over-weight past accruals. The accrual and cash flow effects are distinct from each other in the sense that when we control for one effect, the other effect continues to be significant. However, the cash flow effect on both forecast errors and future stock returns is much stronger, in terms of magnitude, than the accrual effect. The strength of the cash flow effect has not been generally recognized in the literature.

market efficiency, analyst forecast efficiency, accruals, cash flows

Abstract:
A large empirical literature in accounting, economics and finance studies the relation between corporate investment and internally generated cash flows to test for the existence and significance of financing constraints. In this paper, we argue that much of the extant literature confounds the notion of cash flow with accrual accounting net income, which by construction does not represent cash flow. We provide compelling evidence that the documented patterns in investment-cash flow sensitivities across a priori partitions for financial constraints are driven by the fact that the primary cash flow measure used in the literature embeds not only cash flows, but also, via the accrual accounting mechanism, changes in working capital. We show that, in essence, the cash flow variable serves as a proxy for investment in non-cash working capital which has a direct relation to fixed capital investment unrelated to financing constraints. Thus, the empirical patterns documented in the literature really reflect capital investment-working capital investment sensitivities, rather than investment-cash flow sensitivities! The results in this paper provides an important message to researchers who continue to use the investment-cash flow sensitivity approach to study financing constraints, and it is still being used, that they must seriously confront the underlying structure of the cash flow variable used and what it means for the economic interpretation of their empirical results.

Accruals, Cash flows, Investment, growth

Abstract:
Interpreting accruals as working capital investment, we hypothesize that firms rationally adjust their investment to respond to discount rate changes. Consistent with the optimal investment hypothesis, we document that (i) the predictive power of accruals for future stock returns increases with the covariations of accruals with past and current stock returns, and (ii) adding investment- based factors into standard factor regressions substantially reduces the magnitude of the accrual anomaly. High accrual firms also have similar corporate governance and entrenchment indexes as low accrual firms. This evidence suggests that the accrual anomaly is more likely to be driven by optimal investment than by investor overreaction to excessive growth or over-investment.

Abstract:
Interpreting accruals as working capital investment, we hypothesize that firms rationally adjust their capital investment to respond to discount rate changes. Consistent with the discount-rate hypothesis, we document that (i) the predictive power of accruals for future returns increases with the correlations of accruals with past and current stock returns;(ii) controlling for investment substantially reduces the magnitude of the accrual anomaly; (iii) the ex-ante expected returns of various accrual strategies have been stable at around 5% per annum over the past 35 years; (iv) the accounting reliability of various accrual components is inversely related to their cross-correlations with investment-to-assets; and finally (v) high accrual firms have similar corporate governance and entrenchment indexes as low accrual firms, suggesting that the accrual anomaly is unlikely to be driven by investor overreaction to over-investment.

The accruals anomaly, total accruals, discretionary accruals, net operating assets, investment-based asset pricing, capital investment, time-varying expected returns

Abstract:
Prior research has documented that earnings announcements provide information not only about the announcing firm but also about other firms in the same industry. We document a stock market anomaly associated with this phenomenon of intra-industry information transfers by showing that the stock price movements of late announcers in response to earnings reported by early announcers are negatively correlated with the subsequent price responses of late announcers to their own earnings reports. Apparently, the stock market overestimates the intra-industry implications of early announcers' earnings for late announcers' earnings, and that overestimation is corrected when late announcers disclose their earnings.

information transfer, earnings, returns, overreaction

Abstract:
Prior research has documented that earnings announcements provide information not only about the announcing firm but also about other firms in the same industry. We document a stock market anomaly associated with this phenomenon of intra-industry information transfers by showing that the stock price movements of late announcers in response to earnings reported by early announcers are negatively correlated with the subsequent price responses of late announcers to their own earnings reports. Apparently, the stock market overestimates the intra-industry implications of early announcers' earnings for late announcers' earnings, and that overestimation is corrected when late announcers disclose their earnings.

Intra-industry information transfer, market efficiency, stock returns, earnings surprises

Abstract:
We investigate whether surprises in quarterly tax expense predict future returns, after controlling for surprises in after-tax book income. We find that seasonally-differenced quarterly tax expense, our proxy for tax expense surprise, is positively related to future returns over the next two quarters. We confirm that this anomalous link is separate from other anomalies documented in the prior literature, such as size, book-to-market, accruals, and price momentum, as well as two anomalies related to tax variables. While higher expense might intuitively imply bad news, in this case higher tax expense signals good news as it is positively related to pre and after-tax income. Our results suggest that this good news is incorporated in stock prices with a delay because investors do not recognize fully the ability of tax expense surprises to predict two key variables that are released in the next two quarters - future book income and future tax expense.

tax expense, stock return, anomaly, momentum

Abstract:
We examine the long-term stock performance of analyst recommendations and the properties of accompanied earnings forecasts for initiations and non-initiations to evaluate the reporting, selection, and processing explanations for analyst optimism. We find that Strong Buy initiation recommendations under-perform their non-initiation counterparts after controlling for analyst, brokerage and firm characteristics associated with the initiation decision and expected long-term stock returns. Yet, earnings forecasts accompanying Strong Buy initiation recommendations are less optimistic and more accurate than those accompanying Strong Buy non-initiation recommendations. Our findings suggest that conflicts of interest (i.e., the reporting explanation) are the dominant source for favorable recommendations.

Analysts, Conflicts of Interest, Selection Bias, Coverage Initiations

Abstract:
This paper examines the implications of managerial optimism for analysts' forecast bias. Using insider trading behavior to capture managerial optimism, we find that the bias in eight-month-ahead analysts' consensus forecasts is negatively related to the level of managerial optimism. Furthermore, the negative relation is weaker for large firms and for firms with extensive analyst followings, a result supporting the idea that managers exert less influence on analysts if the firms operate in a rich information environment. We also document that the more optimistic the managers, the greater the reduction in analysts' forecasts for current year's earnings, but the smaller the reduction in analysts' forecasts for next year's earnings. This result is consistent with implications of the managerial optimism hypothesis: managers remain optimistic about their companies' futures, even when the current year's performance is disappointing. Finally, we find that the stock price reaction to downward forecast revisions is smaller for firms with more optimistic managers, indicating that investors understand the implications of managerial optimism for analysts' forecast bias and subsequent revisions.

Managerial optimism, analyst forecast

Abstract:
It is well-established that acquisitions are on average value-destroying for the acquirer. This study investigates one possible determinant of acquirer wealth losses. We propose that the negative acquirer returns are partially explained by the change in information uncertainty resulting from the acquisition. Consistent with our predictions, we find that acquisitions lead to a considerable increase in information uncertainty, proxied by absolute analysts' forecast errors and analysts' forecast dispersion. The change in information uncertainty is negatively related to acquirer short-term and long-term stock performance, after controlling for post-acquisition financial performance. In particular, average stock returns are positive for acquirers with a decrease in information uncertainty and negative for acquirers with an increase in information uncertainty. Overall, the relationship between information uncertainty and acquirer stock performance suggests that a portion of acquirer wealth losses are associated with increases in information uncertainty.

Merger, acquisition, return, information uncertainty

Abstract:
Interpreting accruals as working capital investment, we hypothesize based on q-theory that firms optimally adjust their accruals in response to discount rate changes. A higher discount rate means less profitable investments and lower accruals, and a lower discount rate means more profitable investments and higher accruals. Our evidence supports this optimal investment hypothesis: (i) adding an investment factor into standard factor regressions substantially reduces the magnitude of the accrual anomaly, often to insignificant levels; (ii) accruals covary negatively with discount rate estimates from the dividend discounting model, and for the most part, with estimates from the residual income model; (iii) accruals with low accounting reliability covary more with capital investment than accruals with high accounting reliability; and (iv) expected returns to accruals-based trading strategies are time-varying, suggesting that the deterioration of the accrual effect in recent years might be temporary and likely to mean-revert in the near future.

The accruals anomaly, total accruals, discretionary accruals, net operating assets, investment-based asset pricing, capital investment, time-varying expected returns