Research Ideas - 3 /

Firm Complexity and Post-Earnings Announcement Drift

This paper has been written with Alexander Barinov and Shawn Saeyeul Park. The paper shows that the post-earnings-announcement drift (PEAD) is stronger for conglomerates, despite conglomerates being larger, more liquid, and more actively researched by investors. We attribute this finding to slower information processing about complex firms and show that the post-earnings-announcement drift is positively related to measures of conglomerate complexity. We also find that the post-earnings-announcement drift is stronger for new conglomerates than it is for existing conglomerates and that investors are most confused about complicated firms that expand from within rather than firms that diversify into new business segments via mergers and acquisitions.

In this paper we build on the "Complicated Firms" paper written by Cohen and Lou (2012). Cohen and Lou (2012) show that industry-wide news take a lot longer to get incorporated into the prices of conglomerates than for single-segment firms. In this paper we show that earnings-related information is another type of information investors in conglomerates have trouble digesting. 

While doing so we reach three main conclusions: First, the stronger PEAD for complex firms is independent from the return predictability documented by Cohen and Lou (2012) and thus represents a separate case of the impact of firm complexity on stock prices. Second, roughly a quarter of the relation between PEAD and complexity can be attributed to the fact that a unit of SUE has more information for complex firms than for simple firms and another quarter of the relation can be attributed to the relatively low analyst coverage of complex firms after one controls for size. Third, even after controlling for these alternative explanations,complexity per se plays an important role as a limits to arbitrage variable.

While writing this paper perhaps what I was the most surprised about was discovering that single-segment firms receive a lot more analyst coverage than multi-segment firms once one controls for size. This is true whether one uses the number of analysts or the percentage of industry experts as his/her measure of analyst coverage. We plan to expand on this finding further in future papers.

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