Do Investors Overreact to Transnational Peer Firms’ Earnings? Evidence from Financial Reporting Harmonization

Abstract

We find that global financial reporting harmonization is associated with investors overreacting to transnational peer firms’ earnings announcements. Using a sample of 35,116 firm-pair-years from 51 countries between 2000 and 2010, we show that heightened information transfers due to financial reporting harmonization are followed by predictable price reversals when investors observe own-firm earnings. However, overreactions are not present for international firm pairs that follow different accounting standards. Further, the same-standards overreactions are significantly stronger for firms with weaker reporting incentives and higher ownership by retail investors. While we find that institutional investors learn over time and overreactions attenuate, retail investors do not learn over time. Additional tests suggest that overreactions cause significant excess volatility, which results in economically meaningful costs. Collectively, our findings document a potential cost of harmonization in the form of investor overreactions to transnational peer firms’ earnings news.

Keywords: transnational information transfers, investor overreactions, predictable return patterns, financial reporting harmonization

JEL Classification: G15, G41, M40