Qiang Kang

Predicting Stock Market Returns with Aggregate Discretionary Accruals

We find that the positive relation between aggregate accruals and one‐year‐ahead market returns documented in Hirshleifer, Hou, and Teoh [2009] is driven by discretionary accruals but not normal accruals. The return forecasting power of aggregate discretionary accruals is robust to choices of sample periods, return measurements, estimation methods, business condition and risk premium proxies, and accrual models used to isolate discretionary accruals. Our extensive analysis shows that aggregate discretionary accruals, in sharp contrast to aggregate normal accruals, contain little information about overall business conditions or aggregate cash flows and display little co‐movement with ICAPM‐motivated risk premium proxies. Our findings imply that aggregate discretionary accruals likely reflect aggregate fluctuations in earnings management, thereby favoring the behavioral explanation that managers time aggregate equity markets to report earnings.

The Limitations of Stock Market Efficiency: Price Informativeness and CEO Turnover

Stock prices are more informative when the information has less social value. Speculators with limited resources making costly (private) information production decisions must decide to produce information about some firms and not others. We show that producing and trading on private information is most profitable in the stocks of firms with poor corporate governance -- precisely because it will not be acted upon -- and less profitable at firms with better corporate governance. To the extent that the information in the stock price is used for disciplining the CEO by the board of directors, the informed trader has a reduced incentive to produce the information in the first place. We test our model using the probability of informed trading (PIN) and the probability of forced CEO turnover in a simultaneous-equation system. The empirical results support the model predictions. Stock prices are efficient, but there is a limit to the disciplining role they can fulfill. We apply the model to evaluate the effects of the Sarbanes-Oxley Act of 2002.

Information-Based Stock Trading, Executive Incentives, and the Principal-Agent Problem

We examine the role of information-based stock trading in affecting the risk--incentive relation. By incorporating an endogenous informed trading into an optimal incentive contracting model, we analytically show that, apart from reducing incentives, a greater risk increases the level of information-based trading, which consequently enhances executive incentives and offsets the negative risk--incentive relation. We calibrate the model and find that the economic magnitude of this incentive-enhancement effect is significant. Our empirical test using real-world executive compensation data lends strong support to the model prediction. Our results suggest that principals (boards of directors) should consider underlying stock trading characteristics when structuring executive incentives.

CFA Certification Program and Sell-Side Analysts

We examine the effects the Chartered Financial Analyst (CFA) designation program has on recommendation performance and career outcomes of the analysts who complete the curriculum and become charterholders. For these analysts, both their recommendation performance and their chances of making the Institutional Investor’s All-America Research Team increase during 1993–2015. These effects are attributable to the CFA program curriculum. The results remain largely stable across the pre- and post-2000 subperiods, and they survive an array of robustness checks.

Information, Investment Adjustment, and the Cost of Capital

Private information plays a dual role in affecting asset prices –– it imposes information risk on uninformed traders and in the meantime provides firms with valuable signals for investment adjustment. We extend Easley and O’Hara’s (2004) model to show that information adjustment benefits both informed and uninformed investors, so its effect on the cost of capital is opposite to that of information risk. The net effect of private information on the cost of capital depends on which force dominates. Our empirical tests show that value stocks with few investment adjustment opportunities command an information risk premium, while growth stocks that are rich in such opportunities exhibit an information risk discount. These asset pricing results are consistent with the findings that growth firms adjust investments more responsively to information contained in stock prices than value firms.

Cross-Sectional PEG Ratios, Market Equity Premium, and Macroeconomic Activity

This paper exploits information contained in cross-sectional PEG ratios to extract estimates of the markets expectations for aggregate returns and economic fundamentals. By combining the loglinear present-valuation model and the Capital Asset Pricing Model (CAPM) logic, we establish a theoretic link between PEG ratios and expected returns of stocks. Using this theoretic link, we construct one proxy for aggregate market equity premium and one proxy for macroeconomic fundamentals. The equity premium proxy outperforms alternative predictors and has considerable power in forecasting future market returns over the period of May 1983 to December 2009. The equity premium proxy is also able to forecast future macroeconomic activity such as nonfarm payroll growth, personal consumption expenditure growth, nondurable consumption growth, inflation, and unemployment rate. The fundamentals proxy is highly correlated with unemployment rates both concurrently and intertemporally. The results are generally robust across subsample and to various econometric methods for standard-error adjustments. Our study suggests that the choice of cross-section data is critical to information extraction and that the CAPM remains a vital theoretic tool to guide empirical work.