How Informed are Actively Trading Institutional Investors? Evidence from Their Trading Behavior Before a Break in a String of Consecutive Earnings Increases

Abstract

Institutional investors are often assumed better informed but settings in which they are better informed or the sources of their advantage are not identified. We examine a setting that demonstrates institutional investors' information advantage and their source. We show that transient institutions (i.e., those trading actively to maximize short-term profits) predict breaks in strings of consecutive quarterly earnings increases at least one quarter prior to the break quarter. We also provide evidence that one source of their advantage is private communications with management. We find no evidence that other types of institutional investors predict breaks.

JEL Classification: M41, N20, G29, G24, G32