Leon Zolotoy

Earnings Surprise Implicit in Stock Prices: Which Earnings Forecasting Models are Investors Using and What Determines Their Choice?

In this paper we address the issue of modeling the relationship between stock prices and accounting earnings in the presence of potential divergence of opinion regarding the expected company earnings. We introduce a new measure of the earnings surprise, the implied earnings surprise, which we define as the weighted average of the random walk, time series and the analysts’ earnings surprises, with the weights being estimated directly from stock prices. The link function which determines the relationship between the stock returns and the implied earnings surprise is estimated semi�?nonparametrically, allowing our framework to nest a variety of models used in previous studies. Our key findings are as follows. First, we find the weight of the random walk (analysts) forecast to be significantly larger (smaller) for the stocks with low share of institutional holdings and impoverished information environment. Second, we find the choice of a particular earnings forecasting model to be related to its forecast accuracy, an effect which is more pronounced for the institutional investors. Finally, we show how conditioning on the implied measure of the earnings surprise substantially improves the profitability of the post�?earnings announcement drift�?based investment strategies

The effects of societal culture attributes on regional disparity

Purpose - The main goal of this paper is to analyze the effects of societal culture attributes on regional disparity. Design/methodology/approach - This paper uses cross-country data to identify the variables that determine the regional disparity and the gap between the richest and poorest regions in the economy. Findings - The most interesting result of this study is that there exists a significant role played by societal cultural differences in the explanation of the regional disparity and the gap between rich and poor regions. Originality/value - As far as we know, this paper makes the first attempt to explain inter-regional disparity according to culture attributes. We estimate that cultural variables add about 5 percent to the explanation of the variation of the indices of inequality between regions.

The Role of Affect in Shaping the Behavioral Consequences of CEO Option Incentives

We advance behavioral agency theory by exploring the influence of mood or “affect” on the behavioral consequences of stock option incentives. Drawing on insights from psychology and behavioral decision theory, we describe how affect influences agent risk behavior. We argue that positive affect amplifies both the extent to which executives reduce strategic risk taking in response to risk bearing and engage in strategic risk taking in response to incentives for further enrichment. Building again on the psychology literature, we describe how CEO accountability attenuates the influence of affect on CEO risk behavior in response to stock option incentives. We test our expectations in a longitudinal data set of CEO stock option incentives, affect, and strategic risk taking by U.S. firms.

Media Coverage and IPO Pricing Around the World

We study how media coverage impacts pricing of IPOs around the world. Higher media coverage in the pre-IPO period leads to lower IPO initial returns. The effect is mitigated in countries with better financial reporting quality, greater shareholder rights protection, and more stringent media censorship, and for IPOs “certified�? by reputable intermediaries, while it is amplified in countries with higher levels of media penetration and media trust. Further, IPOs with higher pre-IPO media coverage have lower ex-post price revision volatility. Our findings suggest that higher pre-IPO media coverage reduces information asymmetry among investors, leading to less underpriced IPOs.

Obscured by Clouds: The Impact of Weather-Induced Managerial Mood on Corporate Tax Avoidance

We examine the impact of managerial mood on corporate tax avoidance—a ubiquitous corporate decision. Using variation in local sunshine as exogenous shocks to managerial mood, we report strong, robust evidence that negative mood induced by cloudy weather leads firms to undertake more aggressive tax positions. Reinforcing the intuition underlying our main result, we find that negative weather-induced mood is positively associated with managers’ subjective perceptions of firms’ financial constraints, but not with their actual financial constraints. In the cross-sectional analysis, we find that the importance of weather-induced mood to tax avoidance subsides when the board has more financial expertise and the tax audit threat is greater—i.e., in situations when managers are held more accountable for their tax planning decisions. Taken together, our findings cast weather-induced managerial mood as a salient contextual factor shaping corporate tax avoidance decisions.

Executive Equity Risk-Taking Incentives and Firm's Choice of Debt Structure

We examine the impact of executive equity risk-taking incentives on firms’ choices of debt structure. Using a longitudinal sample of U.S. firms, we document that firms with higher sensitivity of executive compensation to stock volatility (vega) rely less on bank debt and more on public debt. We utilize the passage of FAS 123R option expensing regulation as an exogenous shock to management option compensation to account for potential endogeneity of the examined relation. In the cross-sectional analyses, we find that the documented effect of vega is amplified for firms with higher growth opportunities and more opaque financial information. The results of supplemental analyses suggest that firms with higher vega face more stringent bank loan covenants and that public debt mediates the positive relation between vega and firms’ risk-taking. We conclude that, by encouraging risk-taking, higher vega increases firms’ reliance on public debt in order to avoid more stringent bank monitoring.

Stock Liquidity and Corporate Tax Avoidance

We examine the relation between stock liquidity and corporate tax avoidance. Utilizing a quantile regression framework we document the following key results: a) greater stock liquidity is positively (negatively) associated with the lower (upper) tail of the tax avoidance distribution; b) the effect of stock liquidity on both tails of tax avoidance distribution is magnified for firms with higher business uncertainty; and c) the effect of stock liquidity on the lower (upper) tail of tax avoidance distribution is attenuated (magnified) for the financially constrained firms. Our findings are consistent with the positive feedback theories of market microstructure where, by making share prices more informative to managers, greater stock liquidity affects firm’s tax planning.

Time–Varying Dynamics and Asymmetric Effects of the Fama–French Factor Betas

We examine the impact of information shocks on systematic equity risk in a multiple-factor linear model framework. Using nonparametric and parametric models, we test for the presence of asymmetric effects of information shocks on the Fama–French factor betas. Overall, we document that market, size and book-to-market betas display different asymmetry patterns with respect to new information. More specifically, we find that market factor betas increase (decrease) following large negative (positive) market innovations. No evidence of an asymmetric response to the news is found for the size (SMB) factor betas. The book-to-market betas seem to decrease (increase) following large negative (positive) shocks to the book-to-market (HML) portfolio. Based on dynamic estimates of our empirical Fama–French betas we derive the economic values which an investor can gain by using dynamic factor loadings in portfolio selection. Finally, using stochastic dominance principles, we compare the performance of industry hedge portfolios.

Earnings Announcements, Aggregate Earnings, and Individual-Firm Stock Returns: A Signal Extraction Perspective

There is an extensive stream of research that documents a positive association between earnings surprises and stock returns at the individual firm level. We posit that individual firms’ earnings surprises have systematic and firm-specific components that differ in their persistence, implying that the market reaction to individual firms’ earnings surprises should depend upon the relative magnitudes of the underlying systematic and firm-specific earnings surprise components. We further posit that investors behave as if they solve a signal extraction problem that allows them to estimate from aggregate (e.g., market) earnings the systematic earnings surprise component. Our signal extraction framework implies that the market reaction to individual firms’ earnings surprises is increasing in the cross-sectional mean earnings surprise and that the magnitude of the mean effect is inversely related to the cross-sectional dispersion of the earnings surprises. Our results are consistent with these predictions. Also consistent with signal extraction, we find that the effect of the crosssectional mean earnings surprise is significantly larger for firms that announce their earnings early in the quarter. We also find that signal extraction occurs for firms with a large percentage of individual investors, but not a large percentage of institutional investors, consistent with institutional investors having private information that allows them to partition a firm’s earnings surprise into its systematic and firm-specific components. Overall, our results suggest that to understand the market reaction to individual firms’ earnings announcements, one must consider aggregate earnings.

Dispersion of Beliefs, Stock Prices and the Earnings Surprise Measures - A Generalized Approach

In this paper we address the issue of modelling the relation between the stock prices and accounting earnings in the presence of potential divergence of opinions regarding the earnings data generating process among the investors. In our model the markets earnings expectation is defined as the weighted average of both the time-series and analysts forecasts, with the weights being estimated directly from stock returns. No assumptions are made on the functional form of the earnings surprise-stock returns relation, which makes our model flexible enough to incorporate a variety of models discussed in the previous literature. The model is estimated semiparametrically following Hardle et. al [Annals of Statistics, 1993]. Our key findings are as follows. First, we find that investors use both the time-series and analysts forecasts to predict future earnings. Second, the proportion of investors using the time-series (analysts) forecasts is significantly higher (lower) for the stocks with low market capitalization. Third, we find that accounting for the dispersion of earnings forecasts leads to a substantial increase in the magnitude of the post-earnings announcement drift.