Domestic and Foreign Earnings, Stock Return Variability, and the Impact of Investor Sophistication

58 Pages Posted: 28 Sep 2004

See all articles by Jeffrey L. Callen

Jeffrey L. Callen

University of Toronto - Rotman School of Management

Ole-Kristian Hope

University of Toronto - Rotman School of Management

Dan Segal

Interdisciplinary Center (IDC) Herzliyah

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Abstract

We examine whether domestic or foreign earnings contribute more to the variability of unexpected stock returns for a sample of U.S. multinationals and consider the role of investor sophistication. We use a variance decomposition methodology that measures the contribution of each earnings component (and expected future discount rates) to the variance of unexpected returns. We show that the contribution of each earnings component to the variance of unexpected returns depends both on the variance of the earnings component and on its persistence. We document that domestic earnings contribute significantly more to the variability of unexpected returns than do foreign earnings. We further find that the relative variance contribution of foreign earnings is an increasing function of the degree of investor sophistication. Finally, when we classify institutional investors as short-term and long-term following Bushee (1998), we find that the relative variance contribution of foreign earnings increases with the level of investment by long-term investors. In contrast, there is no significant relation between the degree of ownership by short-term (or transient) investors and the relative variance contribution of domestic and foreign earnings. Overall, our results are consistent with Thomas' (1999) finding that investors on average underestimate the persistence of foreign earnings due to lack of understanding of firms' foreign operations caused in part by poor disclosure.

Keywords: Variance contribution, valuation, foreign earnings, investor sophistication

JEL Classification: M41, G14, G12, G32, G23

Suggested Citation

Callen, Jeffrey L. and Hope, Ole-Kristian and Segal, Dan, Domestic and Foreign Earnings, Stock Return Variability, and the Impact of Investor Sophistication. Available at SSRN: https://ssrn.com/abstract=596641 or http://dx.doi.org/10.2139/ssrn.596641

Jeffrey L. Callen

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada
416-946-5641 (Phone)
416-971-3048 (Fax)

Ole-Kristian Hope (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

HOME PAGE: http://www.rotman.utoronto.ca/FacultyAndResearch/Faculty/FacultyBios/Hope.aspx

Dan Segal

Interdisciplinary Center (IDC) Herzliyah ( email )

P.O. Box 167
Herzliya, 46150
Israel

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