Investor Cultural Diversity and Market Reactions to Earnings Announcements

Abstract

We investigate the effect of investor cultural diversity on market reactions to earnings announcements. We measure cultural differences among investors by the ethnolinguistic diversity among local residents around a firm’s headquarters. We show elevated trading volume and stock return volatility around earnings announcements for firms headquartered in locales with high cultural diversity, even when announcements contain little news. Our evidence is consistent with investors in culturally diverse locales having elevated heterogeneous interpretations of public announcements due to heterogeneous disclosure integration costs. Consistent with models of investor disagreement, firms headquartered in culturally diverse locales are also more prone to crash risk. In addition, local cultural diversity is not correlated with measures of firms’ earnings management and innovation expenditures. Our identification strategy instruments local cultural diversity with the extent of geographical isolation.

Keywords: cultural diversity, heterogeneous interpretations, investor disagreement

JEL Classification: G02, G14, M41