RESEARCH
Mutual funds with large capital inflows exert upward price pressure on stocks they purchase as they invest their new capital. We use this price pressure as a relatively exogenous overvaluation indicator, and examine whether managers time SEOs and personal sales. We document that: (i) inflow-driven buying pressure by mutual funds has a pronounced price impact on stocks; (ii) the odds of an SEO increase by about 78%, and managers personally sell about 8.5% more stock, in the four quarters following the buying pressure. This suggests managers are able to identify the overvaluation and transfer wealth from new to current shareholders.
We test the hypotheses that (i) poor accounting quality is one source of market frictions that contribute to stock price delay, and (ii) the portion of price delay due to poor accounting quality is associated with a stock return premium. Price delay is the average delay with which information is impounded into stock prices (Hou and Moskowitz, 2005). Accounting quality measures are based on the quantitative information in financial statements, and results are robust to use of a qualitative characteristic of annual reports (the FOG readability index of Li, 2008) to measure accounting quality. The results are consistent with our hypotheses, suggesting poor accounting quality is economically costly in that it hinders timely price adjustment and increases the cost of equity.
We find evidence of significant increases in short sales immediately prior to large insider sales, consistent with information leakage and front-running. We examine a number of alternative explanations that the increase in short sales is driven by public information about the firm or about the impending insider sale, but the evidence is inconsistent with these explanations. The result has implications for the enforcement of insider information regulations, and for timely disclosure of short sales information by stock exchanges.
We estimate a firm-year measure of accounting conservatism, examine its empirical properties as a metric, and illustrate applications by testing new hypotheses that shed further light on the nature and effects of conservatism. The results are consistent with the measure, C_Score, capturing variation in conservatism and also predicting asymmetric earnings timeliness at horizons of up to three years ahead. Cross-sectional hypothesis tests suggest firms with longer investment cycles, higher idiosyncratic uncertainty and higher information asymmetry have higher accounting conservatism. Event studies suggest increased conservatism is a response to increases in information asymmetry and idiosyncratic uncertainty.
This paper proposes a risk-based explanation for the accrual anomaly. Risk is measured using a four-factor model motivated by the Intertemporal Capital Asset Pricing Model. Tests of the model suggest that a considerable portion of the cross-sectional variation in average returns to high and low accrual firms is explained by risk. The four-factor model also performs better than some other widely used models in pricing a number of different hedge portfolios.
Mispricing and risk have both been suggested as explanations for the cross-sectional relation between stock returns and firm characteristics such as accruals. As emphasized by Ferson and Harvey (1998) and Berk, Green and Naik (1999), it is difficult to evaluate these competing explanations without explicitly modelling the relation between risk and firm characteristics, if risk is not independent of firm characteristics. Drawing on theory and empirical evidence, this paper models systematic risk as a function of accruals, and accruals as mean-reverting. When the true abnormal returns are zero, but the true betas are unobserved by the researcher, the model predicts the anomalous pattern of empirical results previously reported in the accrual anomaly literature and attributed to mispricing: (i) CAPM abnormal returns to an accrual hedge portfolio are positive on average; (ii) the abnormal returns are positive in almost all years; (iii) abnormal returns decay as the holding period is extended beyond one year; (iv) the Mishkin (1983) test of market efficiency is rejected. Using simulations, the paper shows that small and plausible degrees of risk mismeasurement also reproduce the magnitudes of the anomalous results previously reported in the literature.