Are Transient Institutions Sophisticated Enough to Interpret Small Negative Earnings Surprises?

Abstract

Institutional investors (active vs. passive) play various roles in the capital market and in assets prices, in particular. Institutional investors affect assets prices either because they play a monitoring role and mitigate the agency problem, or because they have information advantages, or finally, they can arbitrage away mispricing. This research note relates Hu, Ke, and Yu’s (forthcoming) article to both the traditional positive views that institutional investors are sophisticated and help correct stock mispricing and the complementary emerging literature that argues that institutions may contribute to stock return anomalies rather than eliminate them. My research note concludes that current research on the role of institutional investors has generated a number of useful insights. I identify many fundamental questions that remain unanswered, and changes in the economic environment that raise new questions for research.

Foreign Investors, External Monitoring, and Stock Price Crash Risk

“…Our study echoes Hu, Ke, and Yu (2018) and Trabelsi (2018). They argue that transient institutions analyze and process negative firm information precisely.…”

“…Our results, however, show that foreign financial institutional investors, which focus on short-term trading profits and belong to transient institutions, actually have weaker impacts than foreign nonfinancial corporations on local firms’ future crash risk. The discrepancy might result from the fact that we focus on foreign investors while Hu et al (2018) and Trabelsi (2018) consider all institutional investors. The foreign financial institutional investors in our sample mainly invest through QFII and have quite low average ownership in local firms (around 1.17%).…”