Heterogeneous Beliefs, Speculation of Investors and Voluntary Disclosure

• In Event: Financial Analysis and Investment Decisions

Abstract

This paper investigates how managers alter their financial forecasts in response to speculative trading by investors. Managers may take actions to either maintain the resulting speculative premium or reduce the speculative risk. We adopt Kelly and Pruitt (2015)’s three pass regression filter to measure speculative trading driven by heterogeneous beliefs (disagreement), and establish causality using the exogenous variation in speculative trading after the yearly reconstitution of the Russell 1000 and Russell 2000 indexes. When short sale constraints are binding, managers respond to speculative trading by issuing fewer earnings and sales forecasts, and issuing less precise, longer horizon, and more optimistic earnings forecasts. In contrast, when short sale constraints are not binding, managers respond to speculative trading by issuing more earnings and sales forecasts, and issuing more precise and shorter horizon earnings forecasts. The above results are stronger when managers have stronger equity incentives. We also find that managers trade to take advantage of the resulting price.

Author

• Zhiwei Xu, Rutgers Business School-Newark and New Brunswick