Trust and Market Efficiency

61 Pages Posted: 1 Nov 2014

See all articles by Chishen Wei

Chishen Wei

Singapore Management University - Lee Kong Chian School of Business

Lei Zhang

University of Queensland - Business School

Multiple version iconThere are 2 versions of this paper

Date Written: October 30, 2014

Abstract

If a lack of trust causes investors to discount the information in accounting numbers, then the stock price will tend to under-react to earnings surprises. Using survey measures of interpersonal trust across regions of the United States, we find greater stock price reactions to earnings surprises for firms located in high trust regions. Their counterparts located in low trust regions experience sluggish reactions to earnings news, but subsequently experience greater price drift. Our results are not due to firm characteristics, respondent attributes, or regional differences in economic and social conditions, and are robust to the inclusion of state and firm fixed effects. The impact of trust is mitigated through signaling (i.e., dividend payout and debt) and external certification (i.e., credit rating and auditor choice). Following the passage of the Sarbanes-Oxley Act, the relation between trust and stock price reactions to earnings surprises is eliminated, highlighting the interconnection between regulation, trust, and market efficiency.

Keywords: Trust, Market Efficiency, Earnings Reactions, Auditor Choice, Government Policy and Regulation

JEL Classification: G12, G14, G18

Suggested Citation

Wei, Chishen and Zhang, Lei, Trust and Market Efficiency (October 30, 2014). Available at SSRN: https://ssrn.com/abstract=2517142 or http://dx.doi.org/10.2139/ssrn.2517142

Chishen Wei

Singapore Management University - Lee Kong Chian School of Business ( email )

50 Stamford Road
Singapore
Singapore

Lei Zhang (Contact Author)

University of Queensland - Business School ( email )

Brisbane, Queensland 4072
Australia

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