Umit G. Gurun

Investor Sentiment, Accruals Anomaly, and Accruals Management

This study examines the effect of investor sentiment on the accruals anomaly. We find that for small stocks mispricing per unit of accruals is greater in high sentiment periods as compared with low sentiment periods. This result is consistent with the notion that in high sentiment periods individual investors pay less attention toward understanding the accruals and cash flow components of earnings. This effect is observed primarily for small stocks because these stocks are more likely to be followed by individual investors, who tend to have limited attention. We also find that for small stocks reported accruals are greater during high sentiment periods as compared with low sentiment periods, suggesting that managers exploit the greater overvaluation per unit of accruals during high sentiment periods.

Patent Trolls: Evidence from Targeted Firms

We develop a theoretical model of, and provide the first large-sample evidence on, the behavior and impact of non-practicing entities (NPEs) in the intellectual property space. Our model shows that NPE litigation can reduce infringement and support small inventors. However, the model also shows that as NPEs become effective at bringing frivolous lawsuits, the resulting defense costs inefficiently crowd out firms that, absent NPEs, would produce welfare-enhancing innovations without engaging in infringement. Our empirical analysis shows that on average, NPEs behave as opportunistic patent trolls. NPEs sue cash-rich firms ― a one standard deviation increase in cash holdings roughly doubles a firms chance of being targeted by NPE litigation. We find moreover that NPEs target cash unrelated to the alleged infringement at essentially the same frequency as they target cash related to the alleged infringement. By contrast, cash is neither a key driver of intellectual property lawsuits by practicing entities (e.g., IBM and Intel), nor of any other type of litigation against firms. We find further suggestive evidence of NPE opportunism, such as forum shopping and targeting of firms that have reduced ability to defend themselves against litigation. We find that NPE litigation has a real negative impact on innovation at targeted firms: firms substantially reduce their innovative activity after settling with NPEs (or losing to them in court). Moreover, we neither find any markers of significant NPE pass-through to end innovators, nor of a positive impact of NPEs on innovation in the industries in which they are most prevalent.

The growing problem of patent trolling

Cash-hungry patent trolls are squelching innovation—and should be screened out The last decade has seen a sharp rise in patent litigation in the United States; 2015 has one of the highest patent lawsuit counts on record (1). In theory, this could reflect growth in commercialization of technology and innovation—lawsuits increase as more firms turn to intellectual property (IP) protection to safeguard their competitive advantages. However, the majority of recent patent litigation is driven by nonpracticing entities (NPEs), firms that generate no products but amass patent portfolios for the sake of “enforcing” IP rights (2). We discuss new, large-sample evidence adding to a growing literature (3–7) that suggests that NPEs—in particular, large patent aggregators—on average, act as “patent trolls,” suing cash-rich firms seemingly irrespective of actual patent infringement. This has a negative impact on innovation activity at targeted firms. These results suggest a need to change U.S. IP policy, particularly to screen out trolling early in the litigation process.

Resident Networks and Corporate Connections: Evidence from World War II Internment Camps

Using customs and port authority data, we show that firms are significantly more likely to trade with countries that have a large resident population near their firm headquarters, and that these connected trades are their most valuable international trades. Using the formation of World War II Japanese Internment Camps to isolate exogenous shocks to local ethnic populations, we identify a causal link between local networks and firm trade. Firms are also more likely to acquire target firms, and report increased segment sales, in connected countries. Our results point to a surprisingly large role of immigrants as economic conduits for firms.

Anticipatory and implementation effects of FIN 46 on the behavior of different market participants

We examine whether Financial Accounting Standards Board (FASB)-mandated modifications of the consolidation rules (FIN 46 and FIN 46R) resulted in perceptible changes in market participants’ decisions as manifested in a variety of financial indicia. We find that financial analysts’ idiosyncratic precision of information decreased and equity market participants acted as if they perceived higher information risk, as evidenced by reduced earnings response coefficients, in anticipation of guidance. We attribute these effects to a perceived increase in information risk and decrease in accounting information quality. We find that the actual implementation of the new rules reversed some, but not all, of these effects. On the other hand, we find that information users that likely had access to information regarding the off-balance-sheet debt structures prior to 2001 did not exhibit a similar reaction to the apparent change in information risk either in anticipation or upon implementation of the new guidance. Specifically, we find that banks did not increase the loan spreads for FIN 46 firms and credit rating agencies lowered the ratings of these firms only marginally more than those of other firms. This finding is consistent with our conjecture that these entities were aware of the fundamentals of FIN 46 firms even under the prior limited disclosure regime.

Do Local Capital Market Conditions Affect Consumers' Borrowing Decisions?

This paper uses detailed data from an online peer-to-peer lending intermediary to test whether local access to finance affects consumers’ willingness to pay for loans. After controlling for local economic conditions and borrower credit quality, we find that borrowers who reside in areas with good access to bank finance request loans with lower interest rates. This effect is stronger for borrowers with poor credit and those seeking small loans, suggesting that local access to finance is more important for marginal borrowers. Overall, our findings shed light on how consumers substitute between alternative sources of finance.

Sell-Side Debt Analysts and Debt Market Efficiency

We explore sell-side debt analysts’ contributions to the efficiency of securities markets. We document that debt returns lag equity returns less when debt research coverage exists, which is consistent with debt analysts facilitating the process by which available information is impounded in debt prices. The effect of debt research on the debt market’s lag is incremental to, but comparable in magnitude to, hedge fund ownership’s effect. No such effect exists for credit rating agencies. We also find that the dissemination of debt reports has an immediate effect on return volatility in both markets, which is consistent with debt analysts providing new information to securities markets. Increased return covariation suggests that this information impacts the pricing of debt and equity in the same direction. A large percentage of debt reports do not induce any immediate debt market return reaction but do induce an equity return reaction, which is consistent with new information being provided despite the absence of a debt market reaction. Finally, there is a systematic variation in the debt market’s trading and return reactions to debt research. Timely reports and those by high-reputation brokers induce a quicker trading response, thus enhancing liquidity, whereas only timely reports induce a greater return response. This study illuminates the institutional underpinnings of debt market efficiency, and it has important implications for information content tests in the debt market, where trading is limited. This paper was accepted by Mary Barth, accounting.

Trust Busting: The Effect of Fraud on Investor Behavior

We study the importance of trust in the investment advisory industry by exploiting the geographic dispersion of victims of the Madoff Ponzi scheme. Residents of communities that were exposed to the fraud subsequently withdrew assets from investment advisers and increased deposits at banks. Additionally, exposed advisers were more likely to close. Advisers who provided services that can build trust, such as financial planning advice, experienced fewer withdrawals. Our evidence suggests that the trust shock was transmitted through social networks. Taken together, our results show that trust plays a critical role in the financial intermediation industry. Received April 18, 2016; editorial decision March 8, 2017 by Editor Robin Greenwood.

IQ from IP: Simplifying Search in Portfolio Choice

Using a novel database that tracks web traffic on the SEC’s EDGAR server between 2004 and 2015, we show that institutional investors gather information on a very particular subset of firms and insiders, and their surveillance is very persistent over time. This tracking behavior has powerful implications for their portfolio choice, and its information content. An institution that downloaded an insider-trading filing by a given firm last quarter increases its likelihood of downloading an insider-trading filing on the same firm by more than 41.3% this quarter. Moreover, the average tracked stock that an institution buys generates annualized alphas of over 12% relative to the purchase of an average non-tracked stock. We find that institutional managers tend to track members of the top management teams of firms (CEOs, CFOs, Presidents, and Board Chairs), and tend to share educational and location-based commonalities with the specific insiders they choose to follow. Collectively, our results suggest that the information in tracked trades is important for fundamental firm value and is only revealed following the information-rich dual trading by insiders and linked institutions.

Lenders’ Response to Peer and Customer Restatements

We investigate whether restatements announced by economically related firms influence the contract terms a borrower receives from lenders. A restatement by major customer firm increases the loan spread of a borrower by 11 basis points. The contagion effects of customer restatements are higher (45 basis points) when a borrower’s switching costs are high. Peer restatements also increase a borrower’s loan spread, with lenders reacting more strongly to restatements related to revenue recognition issues. The sensitivity of loan spread to peer restatements is also significantly greater when the restating peer firms are also in the bank’s lending portfolio, suggesting that a lender’s personal experience with restatements in an industry makes its more attuned to the potential implications of these restatements for the borrowing firm. Moreover, our results suggest that lenders utilize information from peer restatements to anticipate future restatements by the borrowing firm.