Responses in Divergence of Opinion to Earnings Announcements: Evidence from American ...

119 Pages·2013·0.61 MB·English

RESPONSES IN DIVERGENCE OF OPINION TO EARNINGS ANNOUNCEMENTS:
EVIDENCE FROM AMERICAN DEPOSITORY RECEIPTS

A dissertation submitted to the
Kent State University Graduate School of Management
in partial fulfillment of the requirements
for the degree of Doctor of Philosophy

by

Fanglin Shen

April 2013

Dissertation written by

Fanglin Shen

B.S., Beihang Univeristy, 2007

M.S., Southern Illinois University Edwardsville, 2008

Ph.D., Kent State University, 2013

Approved by

______________________________Chair, Doctoral Dissertation Committee

______________________________Members, Doctoral Dissertation Committee

______________________________

______________________________

Accepted by

______________________________Doctoral Director, Graduate School of Management

______________________________Dean, Graduate School of Management

iii
iv
ACKNOWLEDGEMENTS
It has been a long and unforgettable journey for me to complete this dissertation. I
am deeply thankful to all those who have helped and supported me.
My most profound gratitude goes to my dissertation chair, Dr. Jayaram
Muthuswamy, for his insightful guidance. Also, I would like to thank other members in
my committee: Dr. Michael Ellis, Dr. Xiaoling Pu, and Dr. Haigang Zhou, for their
suggestions, comments, encouragement, and support.
My great thanks also go to my friends and relatives who helped, encouraged and
companied me through my doctoral studies. I am indebted to all of them.
This dissertation is dedicated to my parents, Jiyun Shen and Yangqiong Shen for
their unreserved love and support throughout my life.

v
TABLE OF CONTENTS
Chapter 1: Introduction ....................................................................................................1

Chatper 2: Literature Review ...........................................................................................6
2.1 Introduction and Literature on ADRs .....................................................................6
2.2 Literature on Earnings Announcements ..................................................................9
2.2.1 “Information Content” and Market Reaction ....................................................9
2.2.2 Adjustment Speed, Timing and Post-earnings Announcement Drift ................ 13
2.3 Literature on Divergence of Opinion .................................................................... 16
2.4 Literature on Short-sales Constraints .................................................................... 21
2.5 Divergence of Opinion with Binding Short-sales Constraints ............................... 23
2.6 Studies that Examine Divergence of Opinion around Earnings Announcements ... 25
2.7 Literature on Country-level Factors. ..................................................................... 28

Chapter 3: Methodolody, Hypotheses and Data.............................................................. 31
3.1 Research Methodology......................................................................................... 31
3.2 Hypotheses .......................................................................................................... 32
3.3 Data Sources ........................................................................................................ 36
3.3.1 Earnings Announcement Dates ....................................................................... 39
3.3.2 Dependent Variables ...................................................................................... 40
3.3.3 Proxies for Divergence of Investors’ Opinions ............................................... 41
3.3.4 Proxies for Short-sales Constraints ................................................................. 45
3.3.5 Control Variables ........................................................................................... 46

Chapter 4: Epirical Results ............................................................................................ 58
4.1 Descriptive Statistics ............................................................................................ 58
4.2 Multivariate Regressions ...................................................................................... 66
4.3 Additional Tests .................................................................................................. 72
4.3.1 Alternative Measure of Excess Earning Announcement Returns .................... 73
4.3.2 Financial Leverage ........................................................................................ 76
4.3.3 Analyst coverage ........................................................................................... 78
4.3.4 Illiquidity, Momentum, Post-earnings Announcement Drift, and Excess
Trading Volume .................................................................................................... 82
4.3.5 Asymmetric Responses ................................................................................. 87
4.3.6 Country-level Variables................................................................................. 91

Chapter 5: Conclusion ................................................................................................. 100

References ................................................................................................................... 103

vi
LIST OF TABLES
Table 1 Distribution of ADRs and Firm-quarter Observations by Country……………….. 38
Table 2 Data Definitions, Measurement and Sources……………………………………… 55
Table 3 Sample Characteristics…………………………………………………………….. 59
Table 4 Correlation Coefficients…………………………………………………………… 64
Table 5 Baseline Model Specifications of Market Reaction in Divergent Opinions around
Quarterly Earnings Announcement………………………………………………..
68
Table 6 Baseline Model Specifications of Market Reaction in Divergent Opinions around
Quarterly Earnings Announcement Using an Alternative Excess Return
Measure…………………………………………………………………………….
75
Table 7 Market Reaction in Divergent Opinions around Quarterly Earnings
Announcement Controlling the Leverage Effect……………………………....
77
Table 8 Market Reaction in Divergent Opinions around Quarterly Earnings
Announcement Controlling the Effect of Analyst
Forecasts…………………………………………………………………………..
80
Table 9 Market Reaction in Divergent Opinions around Quarterly Earnings
Announcement in the Subsample of Zero Analyst Forecast………………………
81
Table 10 Market Reaction in Divergent Opinions around Quarterly Earnings
Announcement Controlling the Effect of Illiquidity, Price Momentum, Post-
earnings Announcement Drift and Excess Trading Volume……………………...
85
Table 11 Market Reaction in Divergent Opinions around Quarterly Earnings
Announcement Using an Alternative SUE Measure…………...............................
86
Table 12 Asymmetric Market Reaction in Divergent Opinions around Quarterly Earnings
Announcement to Good and Bad Earnings Shocks……………………………….
90
Table 13 Market Reaction in Divergent Opinions around Quarterly Earnings
Announcement Controlling the Country-level Factors……………………………
95
Table 14 Market Reaction in Divergent Opinions around Quarterly Earnings
Announcement Conditional on Home-market Short-sales
Feasibility………………………………………………………………………….
99

vii
1

Chapter 1
Introduction

In standard asset pricing models (Lintner 1969; Sharpe 1964), homogeneous beliefs
among investors are presumed. However, financial market participants do not hold homogeneous
beliefs about the asset’s expected return and return probability distribution due to uncertainty.
Thus investors’ forecasts of security valuation may differ from each other. Under these
conjectures, Miller (1977) argues that the price reflects the average expectation of only a small
group of potential investors, the optimistic ones, rather than the universe of investors because the
supply of a single stock is so small compared to the entire universe of stocks and it is purchased
by a minority of investors who highly value the stock. When short-selling is allowed, pessimistic
investors enter the market and correct the mispricing made by the optimistic. If short-selling is
constrained, negative information from pessimistic participants couldn’t be fully reflected in the
price, leading the optimistic participants to overprice the security. Accordingly, the paper
proposes that under heterogeneous beliefs among American Depository Receipts (ADRs)
investors, the higher the divergence of opinion the higher the price when short-sales restrictions
are binding. And such phenomenon is exaggerated when short-selling is more constrained.
Miller (1977) furthers his hypothesis by indicating the convergence of belief dispersion
over time. He asserts to “... believe that the stocks about which there is the greatest divergence of
opinion at any one time tend to have this divergence of opinion narrow over time”, because “…
the passage of time often resolves certain uncertainties about the future of a company” (Miller
1977, p. 1155). Earnings announcements, as major news events, convey “information content”
(Beaver, 1968). Markets react to the new information as a resolution to uncertainty, narrowing
2

the divergence of opinion and lowering pre-event upward biased prices. How investors react to
news in terms of price changes and trading volume is associated with disagreements (Morse,
1981; Bamber, Barron, & Stober, 1997). The above series of market reactions is expected to be
observed around earnings announcements. The release of earnings announcements is one of the
best candidates to resolve the uncertainty.
The results of prior literature on testing Miller’s optimism hypothesis are mixed. Diether,
Malloy, & Scherbina (2002) document the lower future returns associated with higher dispersion
in analysts’ earnings forecasts, which is a proxy for difference of opinion, and the findings are
more pronounced in small and past loser stocks, supporting Miller model. Chen and Jiambalvo
(2004) argue the findings of Diether, Malloy, & Scherbina (2002) can be explained by post
earnings-announcement drift. Johnson (2004) shows that financial leverage captures the cross-
sectional return variation in Diether, Malloy, & Scherbina (2002). Boehme, Danielsen, &
Sorescu (2006) claim that test of Miller hypothesis should examine the interaction effect between
differences of opinion and short-sales constraints. Tests that fail to meet these two conditions
simultaneously are misspecified. They show robust evidence in favor of stock overvaluation
hypothesis. Negal (2005) incorporates the role of short sales in cross-sectional stock return
analysis with divergent opinions and documents supporting new evidence of the Miller
overpricing theory. Doukas, Kim, & Pantzalis (2006) provide competing evidence by using an
advantageous measure of divergent opinion (diversity measure based on Barron, et al., 1998) to
revisit the Miller optimism theory.
Berkman et al. (2009) extend this literature by using quarterly earnings announcements as
events to investigate the Miller hypothesis over a short window. Relatively short but full of
information, the event windows are more likely to mitigate the effects of other factors or