Recent studies propose that limited investor attention causes market underreactions. This paper directly tests this explanation by measuring the information load faced by investors. The investor distraction hypothesis holds that extraneous news inhibits market reactions to relevant news. We find that the immediate price and volume reaction to a firm's earnings surprise is much weaker, and post-announcement drift much stronger, when a greater number of same-day earnings announcements are made by other firms. We evaluate the economic importance of distraction effects through a trading strategy, which yields substantial alphas. Industry-unrelated news and large earnings surprises have a stronger distracting effect.[Attention] is the taking possession by the mind in clear and vivid form, of one out of what seem several simultaneously possible objects or trains of thought . . . It implies withdrawal from some things in order to deal effectively with others.William James, Principles of Psychology, 1890Almost a quarter of British motorists admit they have been so distracted by roadside billboards of semi-naked models that they have dangerously veered out of their lanes.Reuters (London), November 21, 2005 IN SEVERAL KINDS of tests, there is on average a delayed price reaction to news that has the same sign as the immediate response. This phenomenon is ref lected in the new issue and repurchase puzzles (Loughran and Ritter (1995), Ikenberry,

Psychological evidence indicates that it is hard to process multiple stimuli and perform multiple tasks at the same time. This paper tests the investor distraction hypothesis, which holds that the arrival of extraneous news causes trading and market prices to react sluggishly to relevant news about a firm. Our test focuses on the competition for investor attention between a firm's earnings announcements and the earnings announcements of other firms. We find that the immediate stock price and volume reaction to a firm's earnings surprise is weaker, and post-earnings announcement drift is stronger, when a greater number of earnings announcements by other firms are made on the same day. Distracting news has a stronger effect on firms that receive positive than negative earnings surprises. Industry-unrelated news has a stronger distracting effect than related news. A trading strategy that exploits post-earnings announcement drift is unprofitable for announcements made on days with little competing news.[Attention] is the taking possession by the mind in clear and vivid form, of one out of what seem several simultaneously possible objects or trains of thought...It implies withdrawal from some things in order to deal effectively with others.William James, Principles of Psychology, 1890Almost a quarter of British motorists admit they have been so distracted by roadside billboards of semi-naked models that they have dangerously veered out of their lanes.

According to prospect theory (Kahneman & Tversky, 1979), gains and losses are measured from current wealth, which serves as a reference point. We attempted to ascertain to what extent the reference point shifts following gains or losses. In questionnaire studies we asked subjects what stock price today will generate the same utility as a previous change in a stock price. From participants' responses we calculated the magnitude of reference point adaptation, which was significantly greater following a gain than following a loss of equivalent size. We also found the asymmetric adaptation of gains and losses persisted when a stock was included within a portfolio rather than being considered individually. In studies using financial incentives within the Becker, DeGroot, and Marschak (1964) procedure, we again noted faster adaptation of the reference point to gains than losses. We related our findings to several aspects of asset pricing and investor behavior.

We provide a model in which a single psychological constraint, limited attention, explains both under-and overreaction to different earnings components. Investor neglect of earnings induces post-earnings announcement drift and the profit anomaly. Neglect of earnings components causes accrual and cash flow anomalies. The model offers empirical implications relating the strength of earnings-related anomalies to the forecasting power of current earnings-related information for future earnings, investor attentiveness, and the volatilities of and correlation between accruals and cash flows. We also show that, owing to attention costs, in equilibrium not all investors choose to attend to earnings or its components. (JEL G12, G14, M41, M43) Market reactions to earnings and earnings components present a striking puzzle. Stock prices on average underreact to earnings surprises (post-earnings announcement drift), but overreact to the operating accruals component of earnings. 1 Earnings-and accruals-related patterns of return predictability are often referred to as "anomalies," "under-" and "overreaction," or reflecting investor "optimism," "pessimism," or "naïveté." Such labels offer little guidance as to the sources of these effects. Furthermore, a procedure of conjecturing a separate psychological bias for each misreaction pattern creates a problem of model overfitting; explanatory power is bought at the expense of predictive power. Formerly entitled "Limited Investor Attention and Earnings-related Under-and Overreaction," this article was presented at the American Accounting Association Annual Meetings in San Francisco. We thank an anonymous referee, Jennifer Altimuro (the conference discussant), Peng

We examined reference point adaptation following gains or losses in security trading using participants from China, Korea, and the US. In both questionnaire studies and trading experiments with real money incentives, reference point adaptation was larger for Asians than for Americans.Subjects in all countries adapted their reference points more after a gain than after an equal-sized loss.When we introduced a forced sale intervention that highlighted a prior price change, Americans showed greater adaptation toward the new price, whereas Asians showed less adaptation. We offer possible explanations both for the cross-cultural similarities and the cross-cultural differences.