Using a broad sample of earnings announcements, we find a monotonic increase in the spread between call and put implied volatilities as it gets closer to the earnings announcement date. The steady build-up of volatility spread in the days leading up to the announcement date, coupled with the predictive power of cumulative abnormal implied volatility spread on subsequent announcement returns, suggests that informed traders are the driving force behind the option market activities prior to earnings announcements. Such informed trading, as proxied by the abnormal implied volatility spread, increases rather than decreases the stock market response to earnings announcements after controlling for an array of firm and announcement characteristics. This effect is most pronounced when the pre-earnings option trading volume is heightened. Overall, our findings lend strong support to the notion that informed options trading immediately before earnings announcements helps alleviate the stock market under-reaction to earnings announcements and make it closer to a complete response.

Hong and Kacperczyk (2010) document that decreases in analyst competition due to broker mergers encourage analysts to please managers, leading to greater consensus optimism bias. We propose three additional effects of analyst competition. The analyst effort hypothesis suggests that weaker competition reduces analysts’ incentives to collect and analyze information. The herding hypothesis argues that weaker competition reduces analysts’ career concerns, which in turn reduces herding incentives. The strategic deviation hypothesis implies that weaker competition alleviates analysts’ incentives to strategically deviate from others. We find that after broker mergers, analysts follow fewer firms and switch their coverage from firms with more to those with less R&D expenses. They weigh their private information less when it is unfavorable. At the same time, their forecasts become more dispersed. All these findings appear to be more consistent with the analyst effort hypothesis than the herding or strategic deviation hypothesis.