Does the Market Misprice Customer Satisfaction? New Evidence on Errors in Investors’ Expectations

Abstract:     
Studies on the returns of strong versus weak customer-satisfaction stock portfolios provide mixed support for the hypothesis that the financial market misprices the relation between firms’ cash flows and customer satisfaction. None of these studies directly examines whether the market is systematically surprised by this relation, and if so, whether these systematic surprises cause abnormal stock returns. We focus on the key mechanism through which customer satisfaction manifests in abnormal stock returns when the “errors-in-expectations” hypothesis holds. First, we confirm a positive relation between customer satisfaction and a firm’s future cash flow, as measured by future return on assets. Second, we analyze whether investors misunderstand the relation between customer satisfaction and future earnings using data on analysts’ earnings forecasts. For various forecast horizons, we find that analysts anticipate the future earnings associated with customer satisfaction. Third, we show that stock price reactions to firms’ earnings announcements, which reflect investors’ learning about incorrect expectations, are unrelated to customer satisfaction. We reject the hypothesis that customer satisfaction causes abnormal stock returns because of errors in investors’ expectations. More generally, our tests lay new foundations for studies that describe how marketing translates into financial outcomes that are relevant to both companies and investors.

Number of Pages in PDF File: 24

Keywords: customer satisfaction, return on assets, earnings forecasts, earnings announcements, stock return, errors in expectations

working papers series