Previous empirical work on adverse consequences of CEO overconfidence raises the question of why firms hire overconfident managers. Theoretical research suggests a reason: overconfidence can benefit shareholders by increasing investment... more
Previous empirical work on adverse consequences of CEO overconfidence raises the question of why firms hire overconfident managers. Theoretical research suggests a reason: overconfidence can benefit shareholders by increasing investment in risky projects. Using options- and press-based proxies for CEO overconfidence, we find that over the 1993 to 2003 period, firms with overconfident CEOs have greater return volatility, invest more in innovation, obtain more patents and patent citations, and achieve greater innovative success for given research and development expenditures. However, overconfident managers achieve greater innovation only in innovative industries. Our findings suggest that overconfidence helps CEOs exploit innovative growth opportunities.
ABSTRACT This paper provides evidence that analysts are credulous about the discretionary accruals at the time of an initial public offering and a seasoned equity issue. Discretionary accruals in the offering year predict subsequent... more
ABSTRACT This paper provides evidence that analysts are credulous about the discretionary accruals at the time of an initial public offering and a seasoned equity issue. Discretionary accruals in the offering year predict subsequent analysts' forecast errors of annual earnings for as long as four fiscal years after the new issue. The discretionary accruals also predict the analysts' five-year growth forecast errors made in the offering year. The long horizon of the observed credulity matches the three to five year horizon of the new issues puzzle of post-issue stock return underperformance documented in recent studies. Analysts who are unaffiliated with the underwriters of the new issue are equally credulous as affiliated analysts. The evidence provides support for the conjecture that inadequate discounting of financial reports by analysts may have fueled initial investor overoptimism in the new issue.
Earnings management and the underperformance of seasoned equity offerings11We thank Brad Barber (the referee), Randy Beatty, Vic Bernard, K.C. Chan, Kent Daniel, M. DeFond, Laura Field, David Heike, Chuan Yang Hwang, Jonathan Karpoff, S.P. Kothari, Charles Lee, Wayne Mikkelson (the editor), Tim O...more
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We test how market overvaluation affects corporate innovation. Estimated stock overvaluation is strongly associated with measures of innovative inventiveness (novelty, originality, and scope), as well as research and development (R&D) and... more
We test how market overvaluation affects corporate innovation. Estimated stock overvaluation is strongly associated with measures of innovative inventiveness (novelty, originality, and scope), as well as research and development (R&D) and innovative output (patent and citation counts). Misvaluation affects R&D more via a nonequity channel than via equity issuance. The sensitivity of innovative inventiveness to misvaluation increases with share turnover and overvaluation. The frequency of exceptionally high innovative inputs/outputs increases with overvaluation. This evidence suggests that market overvaluation may generate social value by increasing innovative output and encouraging firms to engage in “moon shots.”
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Most applications of behavioral economics, finance, and accounting research to policy focus on alleviating the adverse effects of individuals’ biases and cognitive constraints (e.g. through investor protection rules or nudges). We argue... more
Most applications of behavioral economics, finance, and accounting research to policy focus on alleviating the adverse effects of individuals’ biases and cognitive constraints (e.g. through investor protection rules or nudges). We argue that it is equally important to understand how psychological bias can cause a collective dysfunction – bad accounting policy and financial regulation. We discuss here how psychological bias on the part of the designers of regulation and accounting policy (voters, regulators, politicians, media commentators, managers, users, auditors, and financial professionals) has helped shape existing regulation, and how an understanding of this process can improve regulation in the future. Regulatory ideologies are belief systems that have evolved and spread by virtue of their ability to recruit psychological biases. We examine how several psychological factors and social processes affect regulatory ideologies.
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... First Draft November 1993 Earnings Management and the Long-Term Market Performance of Initial Public Offerings Siew Hong Teoh* TJ Wong** Gita R ... the possibility that investor perceptions about the value of a firm may be man'For... more
... First Draft November 1993 Earnings Management and the Long-Term Market Performance of Initial Public Offerings Siew Hong Teoh* TJ Wong** Gita R ... the possibility that investor perceptions about the value of a firm may be man'For example, Stoll and Curley [1970], Ibbotson ...
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Abstract: We argue that self-deception underlies various aspects of the behavior of investors and of prices in capital markets. We examine the implications of self-deception for investor overconfidence, and how firms and financial... more
Abstract: We argue that self-deception underlies various aspects of the behavior of investors and of prices in capital markets. We examine the implications of self-deception for investor overconfidence, and how firms and financial institutions can exploit the overconfidence of investors in a predatory fashion. These ideas link self-deception to deception by others. We also examine how investor self-deception and overconfidence can affect financial reporting and disclosure policy.
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ABSTRACT We examine the market reward to a walk-down earnings forecast path over the fiscal year horizon (OP for optimistic O to pessimistic P) versus alternative paths (OO, PO, PP) by testing whether the forecast revision path of a given... more
ABSTRACT We examine the market reward to a walk-down earnings forecast path over the fiscal year horizon (OP for optimistic O to pessimistic P) versus alternative paths (OO, PO, PP) by testing whether the forecast revision path of a given earnings announcement affects how the market responds to the announcement. For the period 1984-2006, we find that a market premium for the walk-down path exists in the early years disappears after mid-1990s. In early years pre-1995, investors over-react at the announcement to the positive earnings surprise in the walk-down path and the returns subsequently reverses in the quarter after the earnings announcement after controlling for post-earnings announcement drift effects. Post-1995, there is neither a market premium nor subsequent reversal for the walk-down path. Overall the evidence suggests that investors may have learned over time about the strategic nature of the walk-down path.
ABSTRACT This paper examines accounting earnings and the associated accrual and cash flow components in the years surrounding an initial public offering (IPO) to study the incentives and opportunities for firms to manage earnings when... more
ABSTRACT This paper examines accounting earnings and the associated accrual and cash flow components in the years surrounding an initial public offering (IPO) to study the incentives and opportunities for firms to manage earnings when going public. We identify firm and offering characteristics that may be related to the amount of earnings management in IPO firms. We find that age and ownership retention by original entrepreneurs are significantly negatively related to industry-adjusted discretionary accounting accruals. In addition, we find that net income and cash flow from operations increase in the fiscal year prior to the IPO, and decline significantly in the year of the IPO. Net income continues to decline subsequently but not cash flows. Discretionary working capital and total accruals in the year of the IPO are negatively related to future cash flows and the change in net income between the pre-and post-IPO period. Taken together, the evidence is consistent with a scenario where firms either time an IPO immediately after a year of unusually high cash flow or boost cash flows right before the IPO, and then use accounting accruals to sustain reported net income in the year of the IPO. Thus, the evidence is consistent with the IPO firm attempting to manage investor perceptions with discretionary accruals.
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ABSTRACT
Research Interests: Economics and Public Good
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ABSTRACT This paper tests the hypothesis that irrational market misvaluation a#ects firms' takeover behavior. We employ two contemporaneous proxies for market misvaluation, pre-takeover book/price ratios and pre-takeover ratios of... more
ABSTRACT This paper tests the hypothesis that irrational market misvaluation a#ects firms' takeover behavior. We employ two contemporaneous proxies for market misvaluation, pre-takeover book/price ratios and pre-takeover ratios of residual income model value to price. Misvaluation of bidders and targets influences the means of payment chosen, the mode of acquisition, the premia paid, target hostility to the o#er, the likelihood of o#er success, and bidder and target announcement period stock returns. The evidence is broadly supportive of the misvaluation hypothesis
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ABSTRACT University, and Washington University for helpful comments. Do individual investors drive post-earnings announcement drift? Direct evidence from personal trades This study examines whether individual investors are the source of... more
ABSTRACT University, and Washington University for helpful comments. Do individual investors drive post-earnings announcement drift? Direct evidence from personal trades This study examines whether individual investors are the source of post-earnings announcement drift (PEAD). We provide evidence on how individual investors trade in response to extreme quarterly earnings surprises and on the relation between individual investors ’ trades and subsequent abnormal returns. We find no evidence that either individuals or any sub-category of individuals in our sample cause PEAD. Individuals are significant net buyers after both negative and positive earnings surprises. While postannouncement individual net buying is a significant negative predictor of stock returns over the next three quarters, individual investor trading fails to subsume any of the power of extreme earnings surprises to predict future abnormal returns. This paper examines whether post-earnings announcement drift, or PEAD (Foster, et al. 1984; Bernard and Thomas 1989, 1990), results from trades made by individual investors. PEAD is the tendency for stocks to earn high positive average abnormal returns in the three
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We model limited attention as incomplete usage of publicly available information. Informed players decide whether or not to disclose to observers who sometimes neglect either disclosed signals or the implications of non-disclosure. These... more
We model limited attention as incomplete usage of publicly available information. Informed players decide whether or not to disclose to observers who sometimes neglect either disclosed signals or the implications of non-disclosure. These observers may choose ex ante how to allocate their limited attention. In equilibrium observers are unrealistically optimistic, disclosure is incomplete, neglect of disclosed signals increases disclosure, and neglect of a failure to disclose reduces disclosure. Regulation requiring greater disclosure can reduce observers ’ belief accuracies and welfare. Disclosure in one arena affects perceptions in fundamentally unrelated arenas, owing to cue competition, salience, and analytical interference. Disclosure in one arena can crowd out disclosure in another.
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ABSTRACT We find a positive association between short-selling and accruals, capital expenditures, and (less robustly) NOA among NASDAQ firms during 1988-2003. The associated return anomalies are asymmetric; the absolute value of mean... more
ABSTRACT We find a positive association between short-selling and accruals, capital expenditures, and (less robustly) NOA among NASDAQ firms during 1988-2003. The associated return anomalies are asymmetric; the absolute value of mean abnormal returns is larger for high accrual or high capital expenditure firms than low accrual or low capital expenditure firms on NASDAQ, but not on NYSE. For an NOA-based strategy the return asymmetry is also larger on NASDAQ than on NYSE. These findings indicate that for some firms short arbitrage weakens these anomalies on the down side, but that among NASDAQ firms short sales constraints limit the effectiveness of short arbitrage.
ABSTRACT We provide a model in which a single psychological constraint, limited investor attention, explains several earnings- and investment-related anomalies. Investor neglect of current-period earnings in forming their valuations... more
ABSTRACT We provide a model in which a single psychological constraint, limited investor attention, explains several earnings- and investment-related anomalies. Investor neglect of current-period earnings in forming their valuations induces drift. Neglect of earnings components causes accruals and cash flows to predict abnormal stock returns. Neglect of the incremental forecasting power of other public signals for future earnings causes public information signals such as investment and net operating assets to predict abnormal returns. We derive new untested empirical implications regarding the relative strength of accruals and cash flow anomalies, and the relation between the ability of a public signal to predict returns and its incremental ability to forecast future earnings after controlling for current period earnings.
This chapter reviews psychological influences on accounting and financial rules and regulation. Behavioral accounting and finance has mainly taken regulatory structures as given, and the applications to regulation have mostly been along... more
This chapter reviews psychological influences on accounting and financial rules and regulation. Behavioral accounting and finance has mainly taken regulatory structures as given, and the applications to regulation have mostly been along normative lines—examining how to protect naive investors (eg, Hodder, Koonce, and McAnally, 2001; Kachelmeier and King, 2002; Sunstein and Thaler, 2003), often under the implicit assumption of benevolent and rational regulators (Waymire and Basu, 2008). As for ...
Issuers of initial public offerings (IPOs) can report earnings in excess of cash flows by taking positive accruals. This paper provides evidence that issuers with unusually high accruals in the IPO year experience poor stock return... more
Issuers of initial public offerings (IPOs) can report earnings in excess of cash flows by taking positive accruals. This paper provides evidence that issuers with unusually high accruals in the IPO year experience poor stock return performance in the three years thereafter. IPO issuers in the most "aggressive" quartile of earnings managers have a three-year aftermarket stock return of approximately 20 percent less than IPO issuers in the most "conservative" quartile. They also issue about 20 percent fewer seasoned equity offerings. These differences are statistically and economically significant in a variety of specifications.
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ABSTRACT At the firm level, both operating accruals and a measure of balance sheet bloat (net operating assets, or NOA), negatively predict stock returns. This paper examines whether these anomalies extend to the aggregate stock market.... more
ABSTRACT At the firm level, both operating accruals and a measure of balance sheet bloat (net operating assets, or NOA), negatively predict stock returns. This paper examines whether these anomalies extend to the aggregate stock market. In contrast with cross-sectional findings, there is some indication that aggregate operating accruals positively predict stock market returns. The absence of any negative return predictability is consistent with behavioral explanation for the accruals anomaly, since, in contrast with firm level findings, aggregate accruals are not negative forecasters of earnings after controlling for current-period earnings. Aggregate NOA strongly negatively predicts market returns, but this effect becomes fragile when years 2000-2001 are excluded.