We examine the effect of aggregate cash flow news and discount rate news on momentum returns. We find that momentum profits are higher following aggregate positive cash flow news, even in down markets or low sentiment periods. This finding expands on the evidence in Cooper et al. (2004) that momentum is significant only when past market returns are non-negative and in Antoniou et al. (2013) that momentum is weaker when sentiment is pessimistic. We find that the higher momentum profits during aggregate positive cash flow news periods are primarily driven by the losers continuing to underperform in subsequent periods. Our findings are consistent with the Hong and Stein (1999) model in the sense that gradual diffusion of contradictory news is accentuated when change in wealth is positive and relatively more permanent.

Empirical studies on whether investments are sensitive to cash flows in imperfect markets often report conflicting results and have been criticized on conceptual and methodological grounds. Our study mitigates some of these problems using a research design that relates changes in investment–cash flow sensitivity to changes in the bid-ask spread measure of information asymmetry surrounding (i) implementation of the Sarbanes-Oxley (SOX) Act and (ii) deregulation of firms in the Transportation, Telecommunication, and Petroleum and Natural Gas industries. Consistent with our hypotheses, we find that information asymmetry decreases following SOX and that there is a corresponding decrease in the investment–cash flow sensitivity, pre- to post-SOX. Further, greater decreases in information asymmetry following SOX are associated with greater decreases in investment–cash flow sensitivity. The results for the deregulation sample are also consistent with our hypothesis, wherein we observe an increase in information asymmetry and corresponding increase in the investment–cash flow sensitivity following deregulation.