Chansog Kim

A Test of the Errors-in-Expectations Explanation of the Value/Glamour Stock Returns Performance: Evidence from Analysts' Forecasts

Several empirical studies show that investment strategies that favor the purchase of stocks with low prices relative to conventional measures of value yield higher returns. Some of these studies imply that investors are too optimistic about (glamour) stocks that have had good performance in the recent past and too pessimistic about (value) stocks that have performed poorly. We examine whether investors systematically overestimate (underestimate) the future earnings performance of glamour (value) stocks over the 1976 to 1997 period. Our results fail to support the extrapolation hypothesis that posits that the superior performance of value stocks is because investors make systematic errors in predicting future growth in earnings of out-of-favor stocks. Copyright The American Finance Association 2002.

The Two Faces of Analyst Coverage

We find that positive excess (strong) analyst coverage is associated with overvaluation and low future returns. This finding is consistent with the view that excessive analyst coverage, driven by investment banking incentives and analyst self-interests, raises investor optimism causing share prices to trade above fundamental value. However, weak analyst coverage causes stocks to trade below fundamental values. This finding indicates that investors tend to believe that these firms are more likely to be plagued by information asymmetries and agency problems. The results remain robust after controlling for the possible endogenous nature of analyst coverage and analysts¿ self-selection bias.

Arbitrage Risk and Stock Mispricing

In this paper we examine the relation between equity mispricing and arbitrage risk and find that stocks with high arbitrage risk have higher estimated mispricing than stocks with low arbitrage risk. These results are not limited to high book-to-market or small capitalization stocks, and they are not sensitive to transaction and short-selling costs. In addition, they remain robust to alternative multifactor return generating specification models and mispricing measures. Overall, our empirical results are consistent with the conjecture that mispricing is a manifestation of the inability of arbitrageurs to hedge idiosyncratic risk, a major deterrent to arbitrage activity.

Policy Uncertainty and the Dual Role of Corporate Political Strategies

Firms use active political strategies not only to mitigate uncertainty emanating from legislative activity, but also to enhance their growth opportunities. We find that the impact of such policy uncertainty on systematic risk (beta) can be hedged away by employing various political strategies involving the presence of former politicians on corporate boards of directors, contributions to political campaigns, and corporate lobbying activities. In addition, we show that active political strategies can boost firms’ growth opportunities; they are associated with greater firm heterogeneity and make real options more value-relevant as potential drivers of competitive advantages in uncertain environments.

Readability of 10-K Reports and Stock Price Crash Risk

This paper shows that less readable 10-K reports predict higher stock price crash risk. Using stock price crash risk or, more generally, the third moment of stock return distribution as a powerful indicator of managerial bad news hoarding, our results strongly support the prediction that managers can successfully hide adverse information and boost current stock prices by writing more complex financial reports. Additional analyses show that the effect of financial reporting complexity on crash risk is more pronounced for firms with (persistent) negative earnings news or with transitory positive earnings news, for firms with greater CEO stock option incentive, and for firms with lower litigation risk. We also find that the passage of the Sarbanes–Oxley Act (SOX) does not mitigate the relation between financial reporting complexity and crash risk. Moreover, it appears that textual obfuscation is more significant than earnings management in determining crash risk in the post-SOX era. Finally, firms with less readable financial reports experience sharper price drops during the 2007–2008 financial crisis.