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Expected Mispricing: The Joint Influence of Accounting Transparency and Investor Base

Authors


  • This research remained on-going while Susan D. Krische was an Academic Fellow at the U.S. Securities and Exchange Commission. As a matter of policy, the Commission disclaims responsibility for any private publications or statements by any of its employees or contractors. The views expressed are those of the authors, and do not necessarily represent the views of the Commission or its staff. We appreciate the valuable research assistance of Yoon Ju Kang, Seth Muriset, and Paula Sanders. For helpful comments and suggestions, we thank Raghu Venugopalan, as well as Khaled Abdou, Rob Bloomfield, Jennifer Brown, Rajib Doogar, Jeff Hales, Max Hewitt, Kathryn Kadous, Chandra Kanodia, Wei Li, Laureen Maines, Melissa Martin, Molly Mercer, Derek Oler, Jamie Pratt, Haresh Sapra, Steve Smith, Bill Tayler, Jane Thayer, Greg Waymire, workshop participants at American University, Arizona State University, Emory University, George Washington University, Indiana University, University of Maryland, and University of Illinois at Urbana–Champaign, and the conference participants and anonymous reviewers for the 2009 AAA Annual and Financial Accounting and Reporting Section Meetings and the 2009 Journal of Accounting Research Conference. We thank the individual financial analysts and portfolio managers who generously donated their time and effort by participating in this research. We also thank Eric Hirst and Pat Hopkins for sharing experimental materials.

ABSTRACT

 We examine how accounting transparency and investor base jointly affect financial analysts' expectations of mispricing (i.e., expectations of stock price deviations from fundamental value). Within a range of transparency, these two factors interactively amplify analysts' expectations of mispricing—analysts expect a larger positive deviation when a firm's disclosures more transparently reveal income-increasing earnings management and the firm's most important investors are described as transient institutional investors with a shorter-term horizon (low concentration in holdings, high portfolio turnover, and frequent momentum trading) rather than dedicated institutional investors with a longer-term horizon (high concentration in holdings, low portfolio turnover, and little momentum trading). Results are consistent with analysts anticipating that transient institutional investors are more likely than dedicated institutional investors to adjust their trading strategies for near-term factors affecting stock mispricings. Our theory and findings extend the accounting disclosure literature by identifying a boundary condition to the common supposition that disclosure transparency necessarily mitigates expected mispricing, and by providing evidence that analysts' pricing judgments are influenced by their anticipation of different investors' reactions to firm disclosures.

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