Fundamental to the accounting literature is that firms’ stock prices relate positively to their earnings news. We examine a setting where investors may be unsure to which firm the announced earnings accrue: earnings announced by acquisition targets between the announcement and completion of the acquisition. We find targets’ stock prices relate positively to their unexpected earnings during this interim period but only for unsuccessful M&A deals. For completed deals, we fail to find that targets’ or acquirers’ stock prices respond to targets’ unexpected interim earnings at the time of announcement. However, we find that targets’ interim earnings predict future returns of the combined firm following deal completion. A trading strategy based on targets’ interim earnings produces economically significant annualized abnormal returns of 7.25 percent. Our findings suggest investors respond inefficiently to the earnings that targets announce between the announcement and completion of acquisitions. Data Availability: Data are available from the public sources cited in the text.

We examine whether investor inattention influences managers’ non-GAAP earnings disclosures. Hirshleifer and Teoh’s (2003) theoretical model predicts that managers are more likely to disclose upwardly-biased non-GAAP metrics when investors are inattentive. Employing a measure that captures exogenous variation in institutional investor inattention, we find that managers are more likely to provide non-GAAP disclosures, particularly those where non-GAAP earnings are greater than GAAP earnings, when inattention is high. Moreover, inattention is positively associated with the magnitude of non-GAAP exclusions, which suggests managers present better non-GAAP performance to inattentive investors. Consistent with managers exploiting investors’ limited attention, we find that stock prices respond more strongly to non-GAAP exclusions when investors are inattentive and that managers are more likely to respond to inattention with income increasing non-GAAP disclosures if they sell shares following the disclosure. Taken together, these findings suggest that managers respond opportunistically to inattentive institutions by disclosing aggressive non-GAAP earnings metrics.

We extend prior research examining the relation between aggregate recommendation changes and future returns by documenting that this relation varies over time as a function of the predictability of future earnings growth. When industry-level earnings growth is more predictable, we find that recommendation changes relate negatively to future returns. Our evidence suggests that this negative relation results from analysts revising recommendations upward for higher expected earnings growth but failing to also adjust downward for a related decrease in expected returns arising from a decrease in investor risk aversion. In contrast, when industry-level earnings growth is less predictable, we find that recommendation changes relate positively to future returns. However, this positive relation results from analysts and investors similarly underestimating earnings growth persistence. Overall, the evidence fails to support the claim that analysts' recommendation changes incorporate aggregate information in a manner that adds value to investors by predicting future returns.

Prior research finds that unrealized gains/losses on cash flow hedges are negatively associated with future earnings, and that investors and analysts fail to anticipate this association. These studies speculate that this mispricing is due to either poor derivatives disclosures or the accounting model for cash flow hedges. We examine whether enhanced mandatory derivatives disclosures set forth in FAS 161 improve users' understanding of firms' hedging activities and offer three main findings. First, we find that this mispricing does not persist after FAS 161. Second, we find that the correction of mispricing is greatest when disclosure might help investors most. Finally, we find that analyst forecast accuracy improves after FAS 161. Overall, our results suggest that the enhanced mandatory derivative disclosures required by FAS 161 improved users' understanding of the effects of derivative and hedging activities on future firm performance and firm value—and consequently mitigated investor mispricing.