Limited Attention to Detail in Financial Markets: Evidence from Reduced-Form and Structural Estimation

131 Pages Posted: 9 Jun 2016 Last revised: 26 Jan 2024

See all articles by Henrik Cronqvist

Henrik Cronqvist

Chapman University - The George L. Argyros College of Business and Economics

Tomislav Ladika

University of Amsterdam

Elisa Pazaj

University of Amsterdam

Zacharias Sautner

University of Zurich - Department of Finance; Swiss Finance Institute; European Corporate Governance Institute (ECGI)

Date Written: December 1, 2023

Abstract

We show that firm valuations fell after a key expense became more visible in financial statements. FAS 123-R required firms to deduct option compensation costs from earnings, instead of disclosing them in footnotes. Firms that granted high option pay experienced earnings reductions, while fundamentals remained unchanged. These firms were more likely to miss earnings forecasts, and they experienced recommendation downgrades and valuation declines. Our findings suggest that market participants exhibited limited attention to option costs before FAS 123-R. As we reuse the FAS 123-R natural experiment, we show how one can address confounding channels by integrating reduced-form and structural estimation.

Keywords: Limited attention, option expensing, analyst recommendations, earnings forecasts, FAS 123-R

JEL Classification: G41, G24, G18

Suggested Citation

Cronqvist, Henrik and Ladika, Tomislav and Pazaj, Elisa and Sautner, Zacharias, Limited Attention to Detail in Financial Markets: Evidence from Reduced-Form and Structural Estimation (December 1, 2023). Journal of Financial Economics (JFE), Forthcoming, Available at SSRN: https://ssrn.com/abstract=2790960 or http://dx.doi.org/10.2139/ssrn.2790960

Henrik Cronqvist

Chapman University - The George L. Argyros College of Business and Economics ( email )

1 University Drive
Orange, CA 92866
United States

Tomislav Ladika (Contact Author)

University of Amsterdam ( email )

Roetersstraat 18
Amsterdam, 1018WB
Netherlands
020-5255501 (Phone)

HOME PAGE: http://www1.fee.uva.nl/pp/tladika/

Elisa Pazaj

University of Amsterdam ( email )

Plantage Muidergracht 12
Amsterdam, 1018 TV
Netherlands

Zacharias Sautner

University of Zurich - Department of Finance ( email )

Plattenstr 32
Zurich, 8032
Switzerland

Swiss Finance Institute ( email )

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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