Flight-To-Earnings: The Role of Earnings in Periods of Capital Scarcity

50 Pages Posted: 10 Mar 2017 Last revised: 2 Feb 2021

See all articles by Nicholas M. Guest

Nicholas M. Guest

Cornell University - Samuel Curtis Johnson Graduate School of Management

S.P. Kothari

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Eric C. So

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: January 31, 2021

Abstract

We examine the link between the scarcity of arbitrage capital and investors’ response to firms’ earnings information. The cost of financing levered investment strategies (i.e., investing with borrowed funds) increases in the risk profile of the securities being traded. As a result, when capital is scarce, levered traders face heightened incentives to tilt their portfolios in the direction of firms’ earnings information as an indicator of lesser risk because doing so mitigates financing constraints. Our results suggest these investors become more responsive to firms’ earnings announcements when capital is scarce. Moreover, market prices display a stronger reaction to firms’ announcements and less post-earnings announcement drift. Together, our findings suggest the scarcity of arbitrage capital spurs both the use of, and responsiveness of market prices to, firms’ earnings news.

Keywords: Earnings, Capital Scarcity, Active Investors

JEL Classification: M40, M41, G10, G11, G14, G24

Suggested Citation

Guest, Nicholas M. and Kothari, S.P. and So, Eric C., Flight-To-Earnings: The Role of Earnings in Periods of Capital Scarcity (January 31, 2021). Available at SSRN: https://ssrn.com/abstract=2929704 or http://dx.doi.org/10.2139/ssrn.2929704

Nicholas M. Guest

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

342 Sage Hall
Ithaca, NY 14853
United States

S.P. Kothari (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

E52-325
Cambridge, MA 02142
United States
617-253-0994 (Phone)
617-253-0603 (Fax)

Eric C. So

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

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