Investor Overreactions to Transnational Peer Firm Earnings – The Role of Accounting Standards

Abstract

In this paper, we find that accounting standards play an important role in cross-border investor reactions to peer firms’ earnings. Specifically, we document that when international peer firms report under the same accounting standards, investors overreact to 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 for international same-standard firms 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, same-standards overreactions are significantly stronger for firms that provide lower quality earnings signals. While we find that institutional investors learn over time, overreactions do not decline among retail investors. Additional tests suggest that overreactions cause significant excess volatility, which results in economically significant costs. Collectively, our findings imply that accounting standards are crucial for how earnings news travel worldwide.

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

JEL Classification: G15, G41, M40