Does Firm Life Cycle Stage Affect Investor Perceptions? Evidence from Earnings Announcement Reactions

Abstract

This paper argues that firms in certain life stages may be more subjectively valued by individual investors, leading to an overoptimistic bias in stock prices that is subsequently corrected upon the release of earnings news. Using a cash flow-based life stage classification, introduction and decline stage companies exhibit three-day cumulative abnormal returns (CARs) around earnings announcements that are at least 112 bps lower than firms in growth, maturity, and shake-out stages. Specifically, introduction and decline stage stocks exhibit less positive reactions to positive earnings surprises and more negative reactions to negative earnings surprises relative to companies in other life stages. Lottery stocks’ excess returns around earnings announcements (Liu, Wang, Yu, and Zhao 2020) also vary based on firm life stage. Our findings suggest that individual investors’ overoptimistic expectations for introduction and decline stage stocks are met with disappointment when value-relevant earnings news is released. This study demonstrates that firm life stage has real implications for stock price reactions to earnings announcements in financial markets.

Keywords: Earnings announcements, firm life stage, lottery, returns.

JEL Classification: G10, G12, G14, M41