Investors

I investigate whether a firm’s social capital with investors impacts its non-GAAP reporting decisions. Critics of non-GAAP reporting suggest that non-GAAP earnings are incomplete, inaccurate, and can be misleading (Derby, 2001; Dreman, 2001; Elstein, 2001; Black et al., 2007). Firms might be hesitant to provide non-GAAP information if other means are available to transfer information. Social capital provides an alternate method of informing investors. However, social capital might also play another role in the information environment by building trust between managers and investors (Gabarro, 1978; Gulati, 1995). This trust may reduce investor skepticism of non-GAAP information, enhancing the value of non-GAAP disclosures. Additionally, I examine what impact social capital might have on investors’ investment decisions with respect to non-GAAP reporting. Despite critics’ concerns over non-GAAP reporting, prior literature suggests investors’ reactions are more aligned with the non-GAAP definition of earnings (Bradshaw and Sloan, 2002; Bhattacharya et al., 2003), suggesting other factors might influence investors’ decisions. I investigate whether social capital plays a role in reducing skepticism in non-GAAP information leading to reduced information asymmetry and increased investor reaction to non-GAAP disclosures. I find that non-GAAP reporting is increasing in social capital with investors. However, I find no evidence that investor reactions to non-GAAP earnings information differ based on firms’ social capital with investors. I also find information asymmetry around earnings announcements is higher for non-GAAP reporting firms with greater social capital with investors in comparison to non-GAAP reporters with lower social capital. Taken together, my results suggest social capital impacts the decisions of firms in reporting non-GAAP earnings information, but not the decisions of investors. My results are relevant to the current disclosure environment in that non-GAAP reporting is a current topic of interest for regulators with several updates to non-GAAP guidance having recently occurred.

I examine the determinants and implications of false news on client business risk and firm credibility. False news is defined as information presented as factually accurate, but which contains fabricated facts and is deliberately made public to mislead the reader. Importantly, it is later denied by a credible source. There is a significant concern about the influence of false news on individuals’ decision-making and judgment processes. However, our knowledge regarding false news and its implications for financial markets is minimal. I investigate false news by focusing on negative false news that is not initiated from within the company. Building on financial and political motives behind incidents of false news, I examine whether industry competition and media coverage play a role in making a firm a target for false news. I further examine the impact of false news on the firm’s financial reporting behavior and investigate whether the firm’s auditor prices false news. Lastly, based on the argument that false news increases distrust and uncertainty, I examine whether false news decreases the credibility of the firm’s disclosures and test whether the earnings response coefficient (ERC) is lower after the release of false news. I find that lower competition and higher media coverage are associated with higher likelihood of false news. Consistent with my predictions, I also find that false news target firms have higher abnormal accruals, higher abnormal real earnings activities, and higher audit fees. However, I do not find support for the notion that false news reduces credibility of firm’s disclosure.

In Essay 1, I use cross-country differences in investors’ traits — trust, patience,
overconfidence, and risk tolerance — to test the underreaction, overreaction, and
uncertain information theories of stock returns. I find that investors’ reactions to large
daily stock price shocks vary between lower and higher levels of these traits. Specifically,
investors with lower levels of trust and more patience underreact more (or overreact less)
to price shocks, which aligns with the predictions of the underreaction hypothesis.
Investors with higher levels of overconfidence overreact more to positive price shocks
and overreact less to negative price shocks. While this finding does not conform exactly
to the predictions of the overreaction hypothesis, it is consistent with more refined
theories of how overconfidence affects asset prices. Investors less tolerant of risk
overreact less to positive price shocks. I also find that differences in institutional
characteristics affect over/underreaction. Specifically, there is less overreaction in
countries with stronger investor protections and less insider trading. Additionally, the ability to sell short is associated with more overreaction to negative shocks and less
overreaction to positive shocks.
In Essay 2, I investigate whether publicly available information (PAI) affects
over/underreaction according to predictions of several theoretical models, and then I test
if differences in investors’ traits modifies the association between publicly available
information and returns. After identifying and correcting for a methodological issue in
some prior research, I show that in a pooled international sample of stocks, investors
overreact to price shocks not accompanied by information, and also overreact (or react
efficiently in some models) to information-based price shocks. I find that the effect of
PAI on returns is not the same in each country, which motivates my tests on how this
variability relates to differences in investor traits. My results show that investors with
higher trust tend to overreact less to shocks accompanied by PAI, while investors less
tolerant of risk underreact to positive price shocks. Additionally, investors with higher
overconfidence and self-attribution bias overreact more to positive price shocks, but less
to negative price shocks, in accordance with behavioral theories.