ACCOUNTING


Flight to Earnings: Te Role of Earnings in Periods of Capital


NICHOLAS GUEST ASSISTANT PROFESSOR


Samuel Curtis Johnson Graduate School of Management


Cornell SC Johnson College of Business Cornell University


Scarcity Management Science, 69, 8, August 2023 LINK TO PAPER LINK TO VIDEO


Co-authors • Nicholas Guest


Assistant Professor, Samuel Curtis Johnson Graduate School of Management, Cornell SC Johnson College of Business, Cornell University


• S.P. Kothari, MIT Sloan School of Management • Eric C. So, MIT Sloan School of Management


Summary Classic asset pricing models often assume that investors enjoy an unlimited


access to capital. In practice, capital can be costly to obtain (e.g., Hu et al. 2013). When capital is scarce, the costs of accessing funds likely play a height- ened role in dictating trading decisions. Tis study is motivated by the perva- sive use of levered trading strategies within modern capital markets, which involve traders borrowing capital to amplify their investment returns, (e.g., Shleifer and Vishny 1997). Here, the authors examine the link between the scarcity of arbitrage capital and investors’ response to firms’ earnings infor- mation.


Te cost of financing levered investment strategies (i.e., investing with borrowed funds) increases in the risk profile of the securities being traded. Exploring how levered traders respond to the difficulty of accessing capital and the implications of this response for the pricing of firms’ earnings information, the authors provide novel evidence that levered investors become more responsive to firms’ earnings information when capital is scarce, resulting in a stronger market reaction to earnings announcements (EA) and less post-earnings announcement drift.


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RESEARCH WITH IMPACT: CORNELL SC JOHNSON COLLEGE OF BUSINESS • 2023 EDITION


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