Overpricing: Evidence from Earnings Announcements

Abstract

In the days before earnings announcements we find an average price increase of almost 1 percent for stocks that are likely to be overpriced already - stocks with low institutional ownership combined with high market-to-book ratios, turnover, volatility, or analyst forecast dispersion. However, in the days after earnings announcements these same stocks generate negative abnormal returns of more than 3 percent. Together, these results indicate a significant net correction following earnings announcements for stocks that are prone to be overpriced. These results are consistent with the optimism bias hypothesized in Miller (1977), and with recent evidence that cross-sectional return predictability is concentrated among stocks with low institutional ownership.

Keywords: market efficiency, short-sale restrictions, overpricing, earnings announcements, institutional ownership

JEL Classification: D82, G14, G19, M41