Firm-specific investor sentiment and the stock market response to earnings news

Abstract

We link accounting-based anomalies to investors' behavioral biases and find that investors respond to earnings news differently according to sentiment. The stock price reaction to positive earnings surprises is significantly greater for firms with high sentiment, suggesting that investors are more optimistic about the expected cash flows included in good earnings news for firms with high sentiment. Investors only partially accept information in good earnings news that differs from their expectations for firms with low sentiment. For negative earnings surprises, stock price sensitivity is slightly higher for firms with low sentiment, but this effect is insignificant because investors only partially update their information from bad earnings news regardless of the sentiment level. We observe no difference in the information content of earnings news according to sentiment level that could induce the different stock price sensitivity patterns.