Asymmetric Stock Price Reaction to Good vs. Bad Earnings News: Short Sale Constraints vs. Managers’ Incentives to Withhold Bad News
Posted: 2 Feb 2011 Last revised: 6 Feb 2017
Date Written: July 7, 2011
The negative stock price reaction to bad news disclosures is much larger in magnitude than the positive stock price reaction to good news disclosures. Diamond and Verrecchia (1987) posit that short-selling restrictions cause this asymmetry while Kothari, Shu, and Wysocki (2009) interpret it as evidence that managers withhold bad news and leak good news. This study explores the merits of these two explanations in a joint framework. Two popular measures of short-sale constraints based on institutional ownership and short interest ratios have no incremental power in explaining the asymmetry when factors that influence managers’ incentives to disclose news in a timely fashion are controlled for. Only, the Prob-measure advocated by Ali and Trombley (2006) is incrementally significant in explaining the larger stock price reaction to bad news. Moreover, the fraction of bad news reflected in stock prices prior to bad news disclosures is significantly higher for more short-sale constrained stocks.
Keywords: Asymmetric stock price reaction; short-sale constraints; managerial incentives
JEL Classification: D82, G14, M40
Suggested Citation: Suggested Citation