Internet chat, disagreement, retail trading, and stock returns around earnings announcements

Abstract

This study tests the Miller (1977) hypothesis as an explanation for stock price behavior around technology firms’ earnings announcements during the late 1990s. Specifically, we examine whether the anomalous tendency for stock prices to increase (decrease) before (after) earnings announcements during this period is associated with an increase (decrease) in investor disagreement before (after) the announcement. For a sample of high-tech stocks in 1998, we use the daily number of messages posted on a firm’s Internet message board (chat room) as a measure of the level of investor disagreement about the firm’s prospects. Consistent with Miller, we find that stocks with a larger increase in the level of disagreement before the announcement tend to have a larger pre-announcement price increase, and a larger price reversal after the earnings announcement. We also find that both small and large investors buy before the announcement and sell afterward, although large investors begin selling sooner than retail investors. In addition, we find our disagreement measure is directly related to net initiated order flow from retail investors, but not institutional investors. Finally, we find that the relative amount of retail versus institutional trading in a stock is positively related to the pre-announcement price runup and negatively related to the post-announcement reversal, and that disagreement is significantly associated with these return patterns only for the subsample of stocks with the highest proportion of retail trading. These results are consistent with the view that retail investors are less willing or less able to (short) sell than institutional investors, and they suggest the Miller hypothesis applies more to retail investors than to institutional investors in this setting.