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Title: How market mispricing affects investor behaviour, corporate investment and real earnings management: the UK evidence
Author: Duong, Chau Minh
Awarding Body: University of Kent
Current Institution: University of Kent
Date of Award: 2011
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This thesis empirically investigates how market mispricing affects the behaviour of investors and managers in the context of the UK stock market. The thesis provides important evidence because we need to know the consequences of the market being inefficient before we can establish how important the efficient market hypothesis is. The first empirical chapter looks at how value and glamour investors react to new financial information. Based on the predictions of the well·documented confirmation bias, the chapter hypothesizes that pessimistic value investors are more biased when processing good information since it contradicts their existing beliefs, while optimistic glamour investors are more biased -when processing bad information. In line with the hypothesis, the chapter finds that value investors under-react to good financial information but they could rationally react or over-react to bad financial information. Similarly, glamour investors are found to under-react to bad financial information and rationally react or over-react to good financial information. Being the first study that provides evidence on confirmation bias, the chapter significantly extends the behavioural finance literature. The chapter offers important insight to understand why value and glamour investors over-react to past periormance (thus cause the value premium to exist) while at the same time they may under-react to new financial information (thus makes fundamental-based trading strategies profitable). Such understanding is very important given the widespread value-glamour trading strategies and the predominance of financial information as an information channel. The second empirical chapter introduces an innovative approach to examine the effect of market mispricing on managers' investment decision. Existing evidence on the effect of market mispricing on corporate investment is subject to scepticism. In particular, Tobin's 0, the most important predictor of investment, could capture information about both iv 1 , fundamentals and non-fundamentals. It leads to vague interpretation as to which components actually drive investment. To tackle this challenge, the chapter shows that Q could be decomposed into three components capturing mispricing, investment opportunities and financial leverage. The chapter finds that after controlling for I investment opportunities, leverage and cash flows, market mispricing is indeed an important driver of corporate investment. The effect of mispricing on investment -is found . to be in line with two influential theories, namely the financing and catering channel. The innovative Q decomposition approach adds an important reinforcement to existing evidence on the effect of mispricing on real investment. Moreover, thanks to its ability to disentangle the 'noisy' information content of Q, the proposed decomposition approach could potentially pave the way for subsequent research in th is area. The third empirical chapter examines how market ove r~va l ua ti on affects managers' earnings management behaviour. Existing studies often concentrate on sho rt~t e rm accruals management (i.e. managers exe rc i s~ discretion over accounting choices and estimations) and provide evidence that over·valued firms inflate earnings to maintain high stock price. The key novelty of this chapter is the examination of long~t e rm real earnings management (i.e. managers exercise discretion over real operation decisions). The chapter finds that in the long term, highly valued firms manage earnings downwards via cutting discretionary expenses and u nde r~p roduction . Taken together with the existing evidence of short~term upward accruals management, the chapter suggests that highly valued firms pursue correcting the market in the long term but try to avoid an immediate price drop in the short term. Such explanation is a large step towards a more thorough knowledge of how highly valued firms manage earnings, a topic which is extremely important especially considering the series of collapses in the early 2000s. The chapter also offers useful insight for the boards and audit committees to better perform their duties and for investors to make more informed investment decisions.
Supervisor: Not available Sponsor: Not available
Qualification Name: Thesis (Ph.D.) Qualification Level: Doctoral
EThOS ID:  DOI: Not available