Herding on the Street

Kevin Lewis

November 29, 2022

The Growth of Finance is Not Remarkable
James Brown, Gustav Martinsson & Bruce Petersen
Journal of Financial and Quantitative Analysis, forthcoming


An important literature emphasizes that finance grew rapidly after WWII relative to the full economy and the services sector, but these are poor benchmarks because they mask a broad structural shift from low- to high-skill services. We show that: i) finance is among the most skill-intensive service industries, ii) the evolution of the finance income share closely tracks other high-skill service industries, and iii) finance grew slower than the rest of high-skill services over the past 50 years. The rise of modern finance is not as remarkable as prior research suggests, providing context for debates about the size of finance.

Life is Too Short? Bereaved Managers and Investment Decisions
Clark Liu et al.
Review of Finance, forthcoming


We examine whether bereavement affects managerial investment decisions in large organizations using the exogenous events of managers' family deaths. We find evidence that bereaved managers take less risk in separate samples of mutual funds and publicly traded firms. Mutual funds managed by bereaved managers exhibit smaller tracking errors, lower active share measures, and higher portfolio weights on larger stocks after bereavement events. Firms managed by bereaved CEOs exhibit lower capital expenditures and fewer acquisitions after bereavement events. Further analyses support the emotion-driven explanation over other explanations. The risk-shifting by bereaved managers has negative implications on the performance of funds and firms that they manage.

The Social Signal
Anthony Cookson et al.
University of Colorado Working Paper, October 2022


We examine social media attention and sentiment from three major platforms: Twitter, StockTwits, and Seeking Alpha. We find that attention is highly correlated across platforms, but sentiment is not: its first principal component explains little more variation than purely idiosyncratic sentiment. We attribute differences across platforms to differences in users (e.g., professionals vs. novices) and differences in platform design (e.g., character limits in posts). We also find that sentiment and attention are both positively related to retail trading imbalance, but contain different return-relevant information. Sentiment-induced retail trading imbalance predicts positive next-day returns, in contrast to attention-induced retail trading imbalance, which predicts strongly negative next-day returns. These results highlight the importance of distinguishing between social media sentiment and attention, and suggest caution when studying the social signal through the lens of a single platform.

Can Old Sin Make New Shame? Stock Market Reactions to the Release of Movies Re-Exposing Past Corporate Scandals
Han Jiang et al.
Tulane University Working Paper, May 2022 


We study stock market reactions to the release of movies re-exposing past publicly known corporate scandals. Using a sample of 54 event firms featured in 23 movies, we find event firms have significantly negative and persistent abnormal returns to movie releases. We posit that such negative reactions are associated with the adverse public perception of event firms induced by scandal re-exposing movies. Consistent with this hypothesis, we find more pronounced negative abnormal returns for firms featured in more popular movies. Moreover, event firms experience downward earnings forecast revisions and increased implied costs of capital following movie releases.

Social Media and Financial News Manipulation
Shimon Kogan, Tobias Moskowitz & Marina Niessner
Review of Finance, forthcoming 


We examine an undercover Securities and Exchange Commission (SEC) investigation into the manipulation of financial news on social media. While fraudulent news had a direct positive impact on retail trading and prices, revelation of the fraud by the SEC announcement resulted in significantly lower retail trading volume on all news, including legitimate news, on these platforms. For small firms, volume declined by 23.5% and price volatility dropped by 1.3%. We find evidence consistent with concerns of fraud causing the decline in trading activity and price volatility, which we interpret through the lens of social capital, and attempt to rule out alternative explanations. The results highlight the indirect consequences of fraud and its spillover effects that reduce the social network's impact on information dissemination, especially for small, opaque firms.

When Bigger Is Better: The Impact of a Tiny Tick Size on Undercutting Behavior
Anne Haubo Dyhrberg, Sean Foley & Jiri Svec
Journal of Financial and Quantitative Analysis, forthcoming


Economically insignificant tick sizes encourage undercutting behavior, thus harming market quality. Theoretical work shows that increasing tick sizes in unconstrained markets reduces undercutting and improves market quality. Equity market pricing grids are generally too coarse to test this prediction. We examine a cryptocurrency market with infinitesimal tick sizes where undercutting limit orders acquire price priority without meaningful economic cost. We show that increasing tick sizes reduces undercutting behavior, increases liquidity provision and quoted depth, and reduces transaction costs for institutional and retail-sized trades while decreasing short-term volatility. Tiny tick sizes are suboptimal, supporting increased minimum trading increments in tick-unconstrained markets.

Learning by Consuming
Stephen Brown et al.
NYU Working Paper, October 2022 


Mutual fund managers increase investment allocations to companies manufacturing automobiles they have purchased. This effect is stronger (weaker) when these customer-managers have positive (negative) consumption experiences, as measured by repeat purchases (positive), brand switches, and swift resale after purchase (negative). Periods when customer-managers report positive holdings in companies manufacturing their automobiles are associated with higher subsequent stock returns compared to those when they report zero holdings. Customer-managers are also less responsive to analyst recommendations in adjusting their allocations and appear better able to evaluate automobile recall severity. These results suggest that managers gain value-relevant investible information from their consumption experiences.

Delegation Decisions in Finance
Felix Holzmeister et al.
Management Science, forthcoming 


Based on an online experiment with a sample of finance professionals and participants from the general population (acting as clients), we examine drivers and motives of clients' choices to delegate investment decisions to agents. We find that clients favor delegation to investment algorithms, followed by delegation to finance professionals compensated with an aligned incentive scheme, and lastly to finance professionals receiving a fixed payment for investing on behalf of others. We show that trust in investment algorithms or finance professionals, and clients' propensity to shift blame on others increase the likelihood of delegation, whereas clients' own decision-making quality is associated with a decrease in delegation frequency.

Do Security Analysts Discipline Credit Rating Agencies?
Kingsley Fong et al.
Review of Corporate Finance Studies, November 2022, Pages 815-848 


Credit ratings of corporations are biased, but the forces driving this bias are unclear. We argue it would be difficult for rating agencies to issue high grades for a firm's debt when there are a lot of objective equity analyst reports about the firm's earnings that are informative about its default. We find that an exogenous drop in analyst coverage leads to greater optimism-bias in ratings, especially for firms with little bond analyst coverage and those that are close to default. This coverage-induced shock leads to less informative ratings about future defaults and downgrades and more subsequent bond security mispricings.

Filling in the GAAPs in Individual Analysts' Street Earnings Forecasts
Brian Bratten, Stephannie Larocque & Teri Lombardi Yohn
Management Science, forthcoming 


Analysts' street earnings forecasts are sometimes based on GAAP earnings and sometimes based on non-GAAP earnings, which exclude various GAAP earnings components. Therefore, differences in analysts' street earnings forecasts may capture differences in not only expected performance but also the earnings metric forecasted. We argue that analysts who forecast non-GAAP, rather than GAAP, street earnings are more likely to separately analyze earnings components. Consistent with this argument, we find that analysts who forecast non-GAAP street earnings issue relatively more accurate forecasts. We also argue that excluded earnings components often reflect negative transitory items, and that variation across analysts in the earnings metric forecasted suggests that the negative excluded items are forecasted by only a subset of analysts. Consistent with this assertion, we find that variation across analysts in the earnings metric forecasted is associated with a lower consensus GAAP earnings surprise and lower stock returns around the earnings announcement. Finally, although variation in the earnings metric forecasted is a source of analyst forecast dispersion, we find that it is also incrementally associated with a lower earnings response coefficient, consistent with the existence of transitory items. We therefore find that the variation in the earnings metric forecasted is an important source of analyst forecast dispersion that predicts not only a lower earnings surprise but also a lower earnings response.

Assimilation Effects in Financial Markets
Eliezer Fich & Guosong Xu
Journal of Financial and Quantitative Analysis, forthcoming 


An assimilation bias occurs when people's evaluative judgement is positively influenced by a previously observed signal. We study this effect by examining investors' appraisal of M&A deals announced one day after other firms in the same 1-digit SIC as the merging parties release earnings surprises. Consistent with assimilation effects, acquirers' M&A announcement stock return initially correlates with the previous day's  earnings surprises. This effect reverses after one week. Assimilation generates other distortions as more positive surprises are related to increases in bid competition, takeover premiums, and withdrawn M&As. Evidence from IPOs corroborates the presence of assimilation effects in financial markets.


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