Investor sentiment and timely loss recognition

Abstract

Purpose The purpose of this paper is to investigate the impact of investor sentiment on timely loss recognition by examining a sample of firms for the period 1988-2015. Design/methodology/approach The authors use the accruals-based model of Ball and Shivakumar (2005) and a sentiment measure in their primary analysis. Supporting analyses include an extension of Simpson (2013) using an abnormal accruals analysis with subsamples of firms with bad news, the use of a Khan and Watts (2009) quarter firm-level measure of conservatism and an investigation of the monitoring role played by financial analysts. Findings The study finds that managers strategically report more losses in high sentiment periods than in low sentiment periods. This loss timing behavior results in an average 37.8 per cent increase in the acceleration of loss recognition. This study additionally finds a negative correlation between investor sentiment and abnormal accruals when managers are reporting bad news, and that a greater number of financial analysts following a firm curtails managers’ acceleration of loss recognition in high sentiment periods. Originality/value This study contributes to the corporate disclosure literature by showing that managers strategically recognize losses, and such behavior is more prevalent in high sentiment periods. Managers take advantage of prevailing investor sentiment to accelerate losses in high sentiment periods to mitigate market penalties from reporting bad news.

Investor sentiment and accounting conservatism: evidence from Iran

“…For example, bad news is announced after the market is closed or on holidays. The purpose of this is to reduce the negative economic consequences of bad news, such as lower stock prices (Duong et al, 2018 andDoyle andMagilke, 2015). Haider et al (2021) examined the impact of management ability on accounting conservatism.…”

“…Considering the Securities Market Act of the Islamic Republic of Iran of 2005, which has been developed to protect investors, and the arguments put forward in previous research (Ge et al, 2019;Duong et al, 2018), namely the reduction of litigation risk and agency costs, it is expected that managers in the Iranian capital market use from the strategy of recognizing losses and bad news in a more timely in situations where the investor sentiment is high. With the implementation of this strategy by managers, information asymmetry in the capital market is reduced and the level of efficiency of the capital market is increased.…”

Accounting for investor sentiment in news and disclosures

“…In Baker and Wurgler (2006), "sentiment" was defined as any expectation about future cash flows and risks in investment not explained by known information. Further, a sentiment measure is required as investor sentiment affects stock returns (Duong et al, 2018). Kyle (1985) discusses noisy rational expectation models in which market players operate, and irrational trades occur because of bias and misinformation carried from the news.…”

Timely Loss Recognition Helps Nothing

“…Engaging in the manipulation of losses masks the actual financial performance of the listed companies. Therefore, as discovered by [25][26][27], these modified financial reports cannot transfer useful news to the market, resulting in very low financial reporting quality. References [51][52][53][54] have even confirmed the low financial reporting quality to be followed by weak corporate innovation and investment efficiency while also increasing information uncertainty, etc.…”

“…Most studies on manipulating losses intuitively dissect its effect on financial reporting quality. References [25][26][27] are vivid examples in this stream of research on manipulating losses. Moreover, prior research on price reversals concentrates on the perspectives of market states and company characteristics in the Chinese market, such as [28,29].…”