Perceived Firm Trustworthiness and Market Underreaction to Earnings News

Abstract

We investigate whether investors’ perception of a firm’s trustworthiness affects underreaction to earnings news. We develop a model that predicts how trust helps explain underreaction to news, and test this prediction under three different empirical settings where a firm’s perceived trustworthiness is particularly acknowledged or at risk: a firm’s involvement in socially responsible activities, inclusion in Forbes’ list of “Americas’ 100 Most Trustworthy Companies,” and issuance of accounting restatement. Consistent with the prediction, we find that underreaction to earnings news is stronger when the firm is perceived to be less trustworthy by investors. This result is particularly pronounced for firms with poor earnings quality, low institutional ownership, positive R&D spending, good earnings news, and during the period of financial crisis and high economic uncertainty. We also find that the effect of a firm’s perceived trustworthiness is distinct from the effect of generalized trusting attitudes of investors.

Keywords: Trust, Trustworthiness, Restatement, Corporate Social Responsibility, Post-Earnings Announcement Drift

JEL Classification: G12, G14, M40