Did Regulation Fair Disclosure, SOX, and Other Analyst Regulations Reduce Security

Mispricing?

Edward Lee Norman Strong Zhenmei (Judy) Zhu

The University of Manchester The University of Manchester Fudan University

May 2013

ABSTRACT

Between 2000 and 2003 a series of disclosure and analyst regulations curbing abusive

financial reporting and analyst behavior were enacted to strengthen the information

environment of U.S. capital markets. We investigate whether these regulations benefited

investors by increasing stock market efficiency. After the regulations, we find a significant

reduction in short-term stock price continuation following analyst forecast revisions and

earnings announcements. The effect was more pronounced among higher information

uncertainty firms, where we expect security valuation to be most sensitive to regulation. Also,

analyst forecast accuracy improved in these firms, consistent with reduced mispricing being

due to an improved corporate information environment following the regulations. Our

findings are robust to controls for time trends, trading activity, the financial crisis, analyst

coverage, delistings, and changes in information uncertainty measures. Finally, we find no

concurrent effect among European firms and a regression discontinuity design supports our

identification of the regulatory effect.

JEL classification: G14, G18

Keywords: Disclosure regulations, Analyst regulations, Information uncertainty, Stock returns

                                                            

We acknowledge the comments of Hans Christensen, Gerald Lobo, Richard Taffler, Martin Walker, Eric
Yeung, and seminar participants at the University of Manchester and Xian Jiaotong University. We thank Peter
Iliev for sharing valuable research data. Corresponding author: Norman Strong, Accounting and Finance
Division, Manchester Business School, Booth Street West, Manchester M15 6PL, UK. Tel: +44 161 2754006.
Email: norman.strong@mbs.ac.uk

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1. Introduction

October 2000 to April 2003 witnessed the enactment of a series of disclosure and

analyst regulations affecting U.S. capital markets, designed to improve the corporate

information environment and restore investor confidence. The regulations, which included

Regulation Fair Disclosure (Reg FD), NASD Rule 2711, the amended NYSE Rule 472, the

Sarbanes-Oxley Act (SOX), the Global Research Analyst Settlement, and Regulation Analyst

Certification, were intended to improve capital market transparency by restraining analyst

forecast and financial reporting biases. Previous studies have largely evaluated the benefits

and costs of these regulations through their impact on firm and analyst behavior. From the

policy maker’s viewpoint, however, a crucial question is: Did these regulations strengthen the

corporate information environment in U.S. capital markets and benefit the end-users of

financial information? We answer this question by evaluating whether the regulations

increased informational efficiency by reducing security mispricing in U.S. stock markets.

A firm’s corporate information environment is the equilibrium outcome of a complex

interplay of factors. Foremost among these is the firm’s own disclosures through official

filings, press releases, and briefings, including financial signaling and capital market

transactions. Reports and commentaries by analysts and commentators external to the firm

condition and enhance a firm’s disclosures. Internal and external corporate governance

arrangements and the regulatory system discipline the quality of the corporate information

environment. Beyer et al. [2010] characterize the corporate information environment in terms

of three decisions that shape it, namely managers’ voluntary disclosure decisions, disclosures

mandated by regulators, and analysts’ reporting decisions. Disclosure regulations such as Reg

FD and SOX potentially affected disclosures mandated by regulators directly and the other

two decisions indirectly. Analyst regulations such as NASD Rule 2711, the amended NYSE

Rule 472, the Global Research Analyst Settlement, and Regulation Analyst Certification

potentially affected reporting decisions by analysts directly and firms’ voluntary disclosure

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decisions indirectly. The influence of these regulations on the corporate information

environment, therefore, was potentially substantial. While the literature tends to suggest that

this influence should have been beneficial (e.g., Ke, Petroni, and Yu [2008], Kothari, Shu,

and Wysocki [2009], Amir, Guan, and Livne [2010]), some studies acknowledge that the

regulations may have had adverse effects (e.g., Carney [2006], Sidhu et al. [2008]). We

examine changes in informational efficiency in order to infer whether the regulations

achieved their policy objectives (Simon [1989], Ferrell [2007]).

An inverse relation between security mispricing and the quality of the corporate

information environment is well-established theoretically and empirically (e.g., Merton

[1987], Brav and Heaton [2002], Zhang [2006]). Thus, to the extent that the disclosure and

analyst regulations improved the corporate information environment, they should have

reduced security mispricing. But the impact on mispricing is unlikely to have been

homogenous across firms. As it is harder for investors to anticipate the future earnings of

firms with greater information uncertainty, we expect the valuation of these firms to have

benefited more from an improved corporate information environment. Therefore, if the

regulations reduced security mispricing, we should observe a greater impact among firms

with greater information uncertainty, after controlling for risk and other confounding effects.

To test these predictions, we examine two security mispricing effects. These are the

short-term stock price continuation effects following new information based on analyst

forecast revisions and earnings announcements. The analyst forecast revision effect captures

the speed and efficacy of the price discovery process associated with information that

analysts disseminate (Gleason and Lee [2003]). The post-earnings announcement drift

(PEAD) effect captures the delayed price response due to investors’ failure to appreciate the

full implications of earnings information (Bernard and Thomas [1989]). Changes to the

corporate information environment due to the regulations potentially influenced both

mispricing effects. Analysts act as information intermediaries and are sophisticated end-users

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of financial statement information. Changes in their reporting decisions affect their forecast

revisions directly, while changes in managers’ voluntary disclosures and disclosures

mandated by regulators affect their revisions indirectly. Information disclosed in earnings

announcements influences investor anticipation of a firm’s future earnings performance.

Changes in managers’ voluntary disclosures, mandated disclosures, and analysts’ decisions

affect investor earnings expectations, directly and indirectly. Stock price adjustment delays

can be due to information imperfections (Verrecchia [1980], Callen, Khan, and Lu [2011])

and reduced delays imply an increase in stock market efficiency.

We use eight measures to capture cross-sectional variation in firms’ information

uncertainty. These are accruals quality, based on Francis et al. [2005], firm size, firm age,

analyst coverage, analyst forecast dispersion, cash flow volatility, and stock return volatility,

based on Zhang [2006], and an aggregate measure that considers the joint effect of these

seven individual measures. Empirical studies widely apply the seven individual measures to

capture cross-sectional variation in firms’ information uncertainty. High information

uncertainty firms are likely to be more sensitive, and low information uncertainty firms less

sensitive, to the regulatory changes we consider. Therefore, if the net effect of the disclosure

and analyst regulations on the corporate information environment was beneficial, we expect a

greater reduction in security mispricing among firms with lower accruals quality, smaller

size, shorter listing history, lower analyst coverage, higher analyst forecast dispersion, higher

cash flow volatility, and higher stock return volatility.

Our findings are as follows. From pre- to post-regulation, we observe significant

declines in short-term price continuation effects based on analyst forecast revisions and

earnings announcements. The post-regulation decrease in risk-adjusted returns associated

with these effects is consistent with reduced security mispricing and an increase in the

informational efficiency of U.S. stock markets. Crucially, the reduced mispricing effects are

significantly greater for firms with greater information uncertainty, which is the group we

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expect to be more sensitive to regulatory changes. In other words, the post-regulation

increase in informational efficiency is greater among firms where investors should benefit

more from an improved corporate information environment. This is consistent with the

regulations achieving their objective of improving the corporate information environment.

The fact that we do not observe a similar decline in security mispricing over the same period

for firms with lower information uncertainty, which is the group we expect to be less

sensitive to regulatory changes, reduces the likelihood that alternative explanations of

anomalous stock return predictabilities such as unidentified sources of risk (Fama [1998]) or

data-snooping biases (Lo and MacKinlay [1990]) are at play.

However, an empirical study of the economic consequences of regulatory reform must

rule out confounding effects (Mulherin [2007]). We therefore conduct a series of further

analyses. These confirm our findings are not due to: Time trend effects; investor trading

activity relating to hedge fund ownership, institutional investor ownership, and share

turnover; the effect of the recent financial crisis; changes in analyst coverage; delistings; and

changes in the values of information uncertainty proxies. We also provide evidence of a

greater post-regulation increase in analyst forecast accuracy for firms with greater

information uncertainty, consistent with the regulations leading to a significantly greater

improvement in the corporate information environment of firms where we find a significant

post-regulation reduction in security mispricing effects. Further analysis shows a greater post-

regulation reduction of mispricing effects for firms that experienced a greater increase in

analyst forecast accuracy immediately after the enactment of individual regulations. This

provides a direct link between changes in the corporate information environment due to the

regulations and the subsequent improvement in market efficiency. Further, we provide

evidence that the reduced mispricing effects we observe among U.S. listed firms do not exist

in a large sample of European listed firms over the same period. This mitigates the possibility

that the increased market efficiency in U.S. capital markets that we find is due to some

5
unidentified factor not specific to U.S. markets. Finally, we find further support for our

identification of the regulatory effect by implementing the discontinuity regression design of

Iliev [2010] and showing there is a significantly lower PEAD effect among firms that SOX

Section 404 required to file management reports, relative to exempt counterparts. This shows

that the regulations improved market efficiency among small firms that were likely to have

similar exposures to concurrent changes in the financial, economic, and political

environment.

Our study contributes to two strands of the literature. The first is the debate on the pros

and cons of regulatory intervention in capital markets (Leuz and Wysocki [2008], Ball

[2009]). Some argue that regulatory intervention is necessary to reduce the disadvantage of

unsophisticated investors (Djankov et al. [2003], Shleifer [2005], Ferrell [2007], Zingales

[2009]). Others point out that regulatory intervention is the outcome of political pressure

(Hart [2009]), is difficult to enforce (Stigler [1971], Romano [2005]), and may impose

unintended costs (Linck, Netter, and Yang [2009]). While we do not deny the latter

arguments, our findings support the former view by providing evidence that the disclosure

and analyst regulations we examine increased the informational efficiency of U.S. capital

markets.

The second strand of literature we contribute to is the long-standing debate on market

efficiency. Studies often attribute evidence of security mispricing to investors’ systematic

errors, essentially focusing on the demand-side of information (e.g., De Bondt and Thaler

[1985], Hirshleifer [2001], Skinner and Sloan [2002]). Our research setting offers an

opportunity to observe whether an exogenous and empirically observable factor, in the form

of a mandatory change in the corporate information environment, affected security

mispricing. We provide new insight into the market efficiency evidence by showing that

financial reporting and information intermediaries on the supply-side of information affect

asset pricing anomalies (Daniel, Hirshleifer, and Teoh [2002]). Our evidence suggests that an

6
improved corporate information environment in which accounting disclosure and analysts

play a significant role can increase market efficiency.

The paper continues as follows. Section 2 reviews the relevant literature and develops

hypotheses. Section 3 explains the sample, data, and methodology. Section 4 presents

empirical results, including additional tests. Section 5 summarizes and concludes.

2. Literature Review and Hypotheses

2.1. THE EFFECT OF EARLIER DISCLOSURE REGULATIONS

Empirical research offers mixed evidence on the impact of earlier disclosure regulation,

such as the Securities Act of 1933 and the Securities Exchange Act of 1934. Stigler [1964],

Jarrell [1981], and Simon [1989] find a lower variance of abnormal returns after the 1933 Act,

which implies that security offerings became less risky. However, Benston [1969] finds little

justification for the accounting disclosures required by the Acts, and Benston [1973] finds no

evidence of a decrease in security risk after the 1934 Act. These findings question whether

the regulations made any difference. Chow [1983] even finds a negative stock market

reaction to events associated with the passage of the 1933 Act and argues that this is because

the regulations had unintended consequences for firms’ investment and financing. More

recent studies of these regulations continue to question their benefits by finding no changes in

information asymmetry or market liquidity attributable to the regulations (Daines and Jones

[2005]) and no unusual volatility or trading volume (Mahoney and Mei [2006]).

But, empirical studies document favorable economic consequences of the 1964

Securities Act Amendments and the 1999 Eligibility Rule, which extended the 1933 and 1934

Acts to over-the-counter (OTC) stocks. Greenstone, Oyer, and Vissing-Jorgensen [2006] find

a positive market reaction to the 1964 Amendments among affected firms. Ferrell [2007]

finds a reduction in the volatility of OTC stocks following the 1964 Amendments and

interprets this as evidence that the regulation improved capital allocation. Bushee and Leuz

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[2005] show that the 1999 Rule increased the liquidity of newly compliant firms, consistent

with improved disclosure following the regulation reducing information asymmetry and the

cost of capital. In general, these studies of OTC firms confirm that the disclosure regulations

had an observable impact. Evidence of a substantial impact on less regulated or smaller OTC

firms is consistent with the hypothesis that firms with greater information uncertainty are

more sensitive to improvements in the corporate information environment.

2.2. A SUMMARY OF REG FD, SOX, AND OTHER ANALYST REGULATIONS

The disclosure and analyst regulations we examine closely followed the dotcom bubble

and high profile financial reporting scandals at the start of the millennium. Reg FD was

enacted in October 2000 to prohibit firms from releasing material non-public information to

selective groups or individuals. This covered security analysts, institutional investors, or other

market professionals “who may be likely to trade on the basis of selectively disclosed

information” and any holder of the issuer’s securities where it is “reasonably foreseeable that

such person would purchase or sell securities on the basis of the information” (SEC [2000]).

Reg FD’s objective was to achieve a level playing field for investors by establishing new

requirements for full and fair disclosure by public companies (SEC [2000]). SOX was

enacted in July 2002 to improve the accuracy and reliability of corporate disclosures. It

established a Public Company Accounting Oversight Board (PCAOB), demanded enhanced

financial disclosures, required greater auditor independence, and promoted higher corporate

responsibility and accountability. For instance, SOX required Chief Executive Officers and

Chief Financial Officers to certify the accuracy of financial statements and imposed greater

penalties for managerial misconduct (U.S. Congress [2002]). Many consider SOX to be the

most sweeping disclosure regulation of U.S. capital markets since the 1933 and 1934 Acts.

NASD Rule 2711 (Research Analysts and Research Reports) and the amended NYSE

Rule 472 (Communications with the Public) were approved in May 2002 and implemented in

phases from July to November 2002 (SEC [2002a]). These rules generally sought to eliminate

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interactions and flows of information between analysts who provide research reports and the

investment banking arms of their brokerage firms. The objective was to prevent activities that

give analysts incentives to bias their research. The Global Research Analyst Settlement was

announced in December 2002 and enforced in April 2003. The SEC reached this legal

settlement with the New York Attorney General, the NASD, the NYSE, state regulators, and

large investment firms. The settlement required brokerage firms to implement structural

changes in the production and dissemination of analyst research. It promoted the separation

of investment banking and equity research departments within brokerage firms (SEC

[2002b]). Finally, Regulation Analyst Certification, which became effective in April 2003,

required analysts to disclose potential conflicts of interests surrounding their compensation

and to certify that opinions expressed in their research reports correctly reflected their

personal views (SEC [2003]).

2.3. EMPIRICAL EVIDENCE ON REGULATORY IMPACT AND ECONOMIC

CONSEQUENCES

Several empirical studies document that Reg FD, SOX, and the analyst regulations had

a positive influence on the corporate information environment. There is evidence of increased

disclosure of forward looking information after Reg FD (Heflin, Subramanyam, and Zhang

[2003], Bailey et al. [2003], Nichols and Wieland [2009], Anantharaman and Zhang [2011])

and evidence of the potential benefits of strong internal control under SOX for the quality of

external reporting (Ashbaugh-Skaife et al. [2008]). Studies report that Reg FD and the analyst

regulations increased forecast accuracy (Herrmann, Hope, and Thomas [2008], Hovakimian

and Saenyasiri [2010]), reduced optimistic recommendations (Barber et al. [2006], Kadan et

al. [2009]), increased the relation between forecast accuracy and recommendation

profitability (Ertimur, Sunder, and Sunder [2007]), and improved the positive association

between analyst recommendations and firms’ intrinsic values (Barniv et al. [2009], Chen and

Chen [2009]).

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 Other studies, however, argue that the regulations may not have improved the corporate

information environment. The restrictions SOX imposed may have compromised disclosure

accuracy by requiring accelerated disclosure (Carney [2006]). Reg FD’s elimination of

selective disclosure may have reduced the quality and quantity of information available to

market participants (Russel [2002], Sidhu et al. [2008]) and may have induced analyst

herding by forcing disclosure to be widely disseminated (Arya et al. [2005]). There is even

evidence of reduced analyst forecast accuracy in the short term after Reg FD (Agrawal,

Chadha, and Chen [2006], Kwag and Small [2007]).

To gauge whether the net effect of the regulations was positive or negative, some

studies examine their economic consequences. Economic consequences denote any effects of

the corporate information environment on firm values or on the wealth of those who make

decisions based on the information or are affected by such decisions (Zeff [1978], Holthausen

and Leftwich [1983]). Studies find that SOX improved market liquidity (Jain, Kim, and

Rezaee [2008]), reduced the market premium to meeting or beating analyst expectations

(Koh, Matsumoto, and Rajgopal [2008]), and had potential benefits in terms of cost of equity

effects (Ashbaugh-Skaife et al. [2009]). Studies find that Reg FD reduced: bid-ask spreads

(Gintschel and Markov [2004], Eleswarapu, Thompson, and Venkataraman [2004]); the

asymmetric market reaction to good versus bad news (Kothari, Shu, and Wysocki [2009]); the

cost of equity capital (Chen, Dhaliwal, and Xie [2010]); and informed trading (Chiyachantana

et al. [2004], Ke, Petroni, and Yu [2008], Bernile, Kumar, and Sulaeman [2011]). These

findings are broadly consistent with the regulations producing net benefits by reducing

information asymmetry and promoting a more level playing field for investors.

Empirical studies have not considered whether the regulations affected security

mispricing. This is an important and relevant issue, as evidence of security mispricing

indicates limitations to informational efficiency. This in turn has implications for the efficient

10
allocation of resources in capital markets, which was an important policy objective of the

regulations. Our study fills this research gap.

2.4. THE EFFECT OF THE CORPORATE INFORMATION ENVIRONMENT ON

SECURITY MISPRICING

Beyer et al. [2010] state that capital providers demand corporate information for

valuation and stewardship reasons. In its valuation role, corporate information allows capital

providers to assess the return potential of investment opportunities. Poor information

provision makes it difficult to distinguish more from less profitable firms, leading investors to

underprice high profitability firms and overprice low profitability firms, with consequent

resource misallocation. In its stewardship role, corporate information allows capital providers

to monitor the use of their committed capital. This helps to address the agency problems that

arise from the separation of ownership and control and the consequent resource allocation

issues (e.g., Bushman and Smith [2001]). Since managers have superior information about

their firms, their voluntary disclosures can reduce information asymmetry with outside

investors. Managers may have incentives, however, to withhold private information and

exaggerate their performance (Verrecchia [2001]). This generates roles in the corporate

information environment for regulatory intervention and financial information intermediaries.

The valuation role of corporate information rationalizes the association between

information uncertainty about a firm and security mispricing. A security is mispriced when its

market price deviates from its intrinsic value, contradicting the efficient market hypothesis

and rational asset pricing. Return predictability or price continuation following news

indicates that market prices do not immediately or fully impound price sensitive information.

Delayed price adjustments occur when investors are uncertain in their assessments of firms’

future earnings and revise their assessments through improved understanding or learning

from other investors (Verrecchia [1980], Callen, Govindaraj, and Xu [2000], Callen, Khan,

and Lu [2011]). Researchers have proposed various theories to explain how information

11
uncertainty can lead to security mispricing. Merton [1987] develops a model of capital

market equilibrium in which investors have informational access to a subset of all securities

and shows how this can explain why small firms earn higher returns. Lewellen and Shanken

[2002] argue that investor uncertainty about the parameters of the return or cash flow

generating process can cause stock return predictabilities. Daniel, Hirshleifer, and

Subrahmanyam [1998] and Hirshleifer [2001] argue that investors are more prone to

behavioral biases in valuing securities for which information is sparse. Hirshleifer,

Subrahmanyam, and Titman [1994] suggest that herding can occur when information is not

available to all investors at the same time.

Empirical studies largely confirm the relation between information uncertainty and

security mispricing. For example, Francis et al. [2007] show that price continuation following

earnings announcements is more pronounced among firms with lower accruals quality. This

supports Brav and Heaton’s [2002] conjecture that investors place less weight on lower

quality signals. Gleason and Lee [2003] show that the price continuation effect following

analyst forecast revisions is more pronounced among firms with less analyst following. This

is consistent with the finding of Elgers, Lo, and Pfeiffer [2001] that investors’ price response

to value-relevant information in analyst earnings forecasts is less complete when firms have

less analyst coverage. Zhang [2006] also documents that the analyst forecast revision effect is

concentrated among firms with more volatile underlying fundamentals and less information

available. Zhang interprets this as evidence that investors are more likely to underreact to

news from firms with greater information uncertainty, consistent with the behavioral theory

of Daniel, Hirshleifer, and Subrahmanyam [1998].

Zhang [2006, p. 108] states further that, “My evidence also suggests a potential

additional role for accounting disclosure: More transparent disclosure might reduce

information uncertainty and speed the absorption of new information into the stock prices”.

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Our study directly addresses this issue by examining the impact of Reg FD, SOX and other

analyst regulations on the security mispricing effects that Zhang examines.

2.5. TESTABLE HYPOTHESES

The previous literature review suggests two main findings that motivate our study.

First, the disclosure and analyst regulations enacted between 2000 and 2003 influenced the

corporate information environment of U.S. capital markets. Second, the valuation role of the

corporate information environment means it affects security mispricing. Previous studies

have not linked these two findings. The high profile financial reporting scandals at the start of

the millennium provide evidence of managerial incentives to distort corporate information.

This justifies the existence of disclosure regulation and analyst research to compensate for the

limitations of firms’ voluntary disclosures. The contribution of biased analyst research to the

overvaluation of dotcom stocks in the late 1990s shows how influential the information

supplied by analysts can be to the corporate information environment, especially for

unsophisticated and individual investors. It also highlights how weaknesses in this component

of the corporate information environment can induce security mispricing, in turn impeding

the efficient functioning of the capital market in allocating financial resources.

It was these problems that motivated policy makers to enact Reg FD, SOX, and the

analyst regulations, with the intention of enhancing information transparency, restoring

investor confidence, and promoting fairness in capital markets. Since all these disclosure and

analyst regulations had similar policy objectives and were introduced consecutively over a

three-year period, it is difficult to distinguish their individual effects. Thus, following

Bradshaw’s [2009] recommendation, we evaluate their joint impact.

Evidence on changes in security mispricing is useful to evaluate the net impact of these

regulations for the following reasons. First, security valuation is one of the fundamental

reasons why investors demand corporate information. Second, the effect of information

uncertainty on security mispricing is well established both theoretically and empirically.

13
Third, security prices are the equilibrium outcome of investor decisions that incorporate

multiple sources of information and reflect the complicated interactions between components

of the corporate information environment. Fourth, sophisticated institutional investors and

unsophisticated individual investors influence security prices, and changes in the corporate

information environment affect each investor group differently.

The two security mispricing effects we examine are especially suited to analyzing the

impact of the regulations. Reg FD and the analyst regulations affected the quality of

information supplied by analysts directly, while SOX affected it indirectly. Changes in price

continuation following analyst forecast revisions, therefore, can show whether changes in the

quality of information supplied by analysts influenced the price discovery process. Similarly,

changes in PEAD capture the net effect of the regulations, as earnings expectations reflect the

influence of all aspects of the corporate information environment across investors. Changes

in the PEAD effect can therefore show whether there was a change in the corporate

information environment, comprising analysts’ forecasts and firms’ disclosures, either

mandated by regulation or voluntary, that affected investors’ ability to anticipate future firm

performance and, hence, the price discovery process. Finally, other stock return anomalies

documented in the literature are less suitable for our study. Evidence of risk compensation

explanations questions whether the size effect (Berk [1995], Fama and French [1996]), the

value-growth effect (Fama and French [1996], Chen, Petkova, and Zhang [2008]), the analyst

forecast dispersion effect (Johnson [2004]), and the accrual effect (Khan [2008], Wu, Zhang,

and Zhang [2010]) are due to mispricing. In contrast, short-term price continuation effects

after analyst forecast revisions (Gleason and Lee [2003], Zhang [2006]) and earnings

announcements (Bernard and Thomas [1989], Francis et al. [2007]) are more clearly

associated with mispricing. We do not consider the past return momentum effect, for two

reasons. First, there is a more direct link between the influence of the disclosure and analyst

regulations we consider and the analyst forecast revision and PEAD effects. Second, the past

14
return momentum effect is one of the four risk factors in the Fama and French [1996] and

Carhart [1997] asset pricing model that we use in our study.

The above arguments and discussion lead to the following testable hypothesis:

H1: Following Reg FD, SOX, and other analyst regulations introduced between 2000

and 2003, the security mispricing effects associated with analyst forecast revisions and

earnings announcements decreased.

However, we expect cross-sectional variation in firms’ information uncertainty to

influence the effect of these regulations. If the regulations improved the corporate

information environment, the ability of investors to anticipate future earnings should have

increased more for firms with greater information uncertainty. This in turn should lead to a

greater reduction of security mispricing effects among these firms. This expectation is

consistent with evidence on the influence of earlier disclosure regulations discussed in section

2.1. Given these arguments, we hypothesize:

H2: The reduced security mispricing effects associated with analyst forecast revisions

and earnings announcements following the enactment of Reg FD, SOX, and other

analyst regulations introduced between 2000 and 2003, were more pronounced among

firms with greater information uncertainty.

We are aware that evidence in favor of these hypotheses could be due to confounding

effects. First, there could be a time trend of increasing informational efficiency in capital

markets due to factors such as a continuous improvement in information dissemination

technologies and investor education (Busse and Green [2002]). Second, an increase in hedge

fund activity, institutional trading, or trading by investors in general due to reduced trading

costs (Chordia, Roll, and Subrahmanyam [2011]) could have arbitraged away the mispricing

effects. Third, the recent financial crisis could have affected investors and their valuations of

securities in unpredictable ways (Easley and O’Hara [2010]). Fourth, changes in our post-

regulation sample due to analysts reducing their coverage of firms (Kelly and Ljungqvist

15
[2011]) or firms choosing to go private to avoid compliance costs (Engel, Hayes, and Wang

[2007]) may affect our results. Finally, the reduction in stock market inefficiency we observe

in U.S. stock markets may be due to an unidentified factor that also affected firms listed

outside the U.S. Our subsequent analysis addresses each of these confounding effects.

3. Research Design and Data

3.1. HYPOTHESIS TESTS

To implement our tests, we use two news proxies, namely analyst forecast revisions and

standardized unexpected earnings, and eight information uncertainty proxies, namely accruals

quality, firm size, firm age, analyst coverage, analyst forecast dispersion, cash flow volatility,

stock return volatility, and an aggregate measure constructed as the average of the seven

individual proxies. This enables us to test our hypotheses on 16 combinations of news and

information uncertainty proxies, strengthening the robustness of our results. The appendix

defines these variables. To test hypothesis H1, we partition stocks by analyst forecast

revisions into three groups based on downward (DR), zero (NR), and upward (UR) revisions

and by standardized unexpected earnings into quintiles (SUE1 to SUE5) according to NYSE

breakpoints. To test hypothesis H2, we further partition each group into quintiles based on

information uncertainty proxies according to NYSE breakpoints. Portfolios are formed at the

end of month t–1 and held for one month. Stocks are equal weighted in the portfolios

(following Zhang [2006]), since we use market value as one of our information uncertainty

proxies and value weighting stocks would reduce the power of our test for high information

uncertainty firms. To estimate risk-adjusted returns, we estimate time-series regressions of the

following four factor model (Fama and French [1996], Carhart [1997]) on portfolio returns:

Rt  Rft  α  βMKTt  sSMBt  hHMLt  uUMDt  εt (1)

16
where for each month t, R – Rf is the excess return of the test portfolio, MKT is the value-

weighted market excess return, SMB is the size premium factor, HML is the value premium

factor, and UMD is the momentum factor.1

Figure 1 illustrates our research design. The hedge portfolio return shows the

magnitude of the subsequent return spread across UR and DR portfolios in the case of the

analyst forecast revision effect, or across SUE5 and SUE1 portfolios in the case of the PEAD

effect. As a result of the positive cross-sectional relation between security mispricing and

information uncertainty, these hedge portfolio returns should be higher among high

information uncertainty firms. The difference in hedge portfolio returns between high and

low information uncertainty firms should be wider during the pre-regulation period

(01/1983–09/2000), before the regulations improved the corporate information environment.

As we hypothesize that investor valuations of high information uncertainty firms benefit

more from an improved corporate information environment, we expect these firms to be more

sensitive and lower information uncertainty firms to be less sensitive to the regulatory

changes.

We examine the change in hedge portfolio returns from the pre- to post-regulation

periods (from 01/1983–09/2000 to 05/2003–12/2011) separately in high and low information

uncertainty firms. The difference in the changes for these two groups gives a difference-in-

differences test. Evidence supporting our predictions pertains if we observe that the hedge

portfolio returns of high information uncertainty firms show a significant reduction (scenario

2) and the hedge portfolio returns of low information uncertainty firms show insignificant

changes (scenario 3). The evidence does not support our predictions if we observe

insignificant changes in high information uncertainty firms (scenario 1). Equally, observing a

significant decline in low information uncertainty firms (scenario 4) suggests that

                                                            
1
Monthly data on the factors and the risk-free interest rate are from the Wharton Research Data Service.

17
unidentified confounding effects unrelated to the informational impact of these regulations

drive changes in hedge portfolio returns.

3.2. DATA AND SAMPLE

Our data are from five sources. Returns, share prices, trading volumes, and shares

outstanding are from the Center for Research in Security Prices (CRSP) monthly and daily

stock files. Firm-level accounting data including fiscal year-end share prices are from

Compustat. We match accounting data with fiscal years ending in calendar year t−1 to returns

from July of year t to June of year t+1. Analyst earnings forecast data and actual earnings are

from the Institutional Brokers’ Estimate System (I/B/E/S) detail and summary files.

Following Diether, Malloy, and Scherbina [2002], we compute consensus analyst forecast

data from the I/B/E/S detail files. Institutional holding data are from the Wharton WRDS 13F

database. We use a comprehensive list of hedge funds from Thomson Reuters Lipper IM,

which we merge with the Wharton WRDS 13F database to obtain hedge fund holdings data.

The sample includes common stocks (share codes 10 and 11) traded on

NYSE/AMEX/NASDAQ (exchange codes 1, 2, and 3) with monthly earnings forecast data

from I/B/E/S. We exclude firms with negative book values and stocks with prices below $5 at

the end of each month to avoid small, illiquid stocks or bid-ask bounce effects driving our

results. We require sample stocks to have at least 12 months past stock returns on CRSP, to

avoid issues relating to recent IPOs. Finally, we exclude observations where the absolute

value of an earnings forecast revision exceeds the previous fiscal year-end price, because

these observations may be erroneous. The sample period spans January 1983 to December

2011.2 However, as any or all of the regulations enacted from October 2000 to April 2003

may have improved analyst behavior, our main test defines this as a transition period and uses

a pre-regulation period from January 1983 to September 2000 and a post-regulation period

from May 2003 to December 2011.

                                                            
2
Earnings forecast data on the I/B/E/S detail files before 1983 are very sparse.

18
3.3. DESCRIPTIVE STATISTICS

Table 1 reports descriptive statistics for the pre-regulation (panel A) and post-regulation

(panel B) periods. Median values of monthly holding period returns (RET), standardized

unexpected earnings (SUE), and analyst forecast revisions (REV) are broadly consistent

across the periods. For the information uncertainty proxies, market value (MV) increases from

a median $331.06 million pre-regulation to $916.69 million post-regulation, indicating the

growth of U.S. stock markets. Median values of accruals quality (AQ), firm age (AGE),

analyst following (COV), analyst forecast dispersion (DISP), cash flow volatility (CVOL),

stock return volatility (SIGMA), and the aggregate information uncertainty measure

(Aggregate IU) are similar in both periods. Indeed, most of the proxies we use to identify

cross-sectional variation in information uncertainty are comparable pre- to post-regulation.

Median analyst forecast accuracy (FA) increases from −0.69% pre-regulation to −0.40% post-

regulation, consistent with prior studies that find analyst forecast accuracy improved after the

regulations (Ertimur, Sunder, and Sunder [2007], Kadan et al. [2009]). From pre- to post-

regulation, median hedge fund ownership (HO) increased from 2.21% to 11.24%, median

institutional investor ownership (IO) increased from 39.65% to 73.51%, and median

(demeaned) turnover (TO) increased from −6.73 to 2.64. These patterns suggest an increase

in institutional investment and trading activity (Chordia, Roll, and Subrahmanyam [2011]),

which we address in our analysis of confounding effects.

4. Empirical Findings

4.1. TESTS OF HYPOTHESIS H1

Table 2 presents our test of hypothesis H1, with panel A examining the analyst forecast

revision effect and panel B the PEAD effect. In each case, we report raw and risk-adjusted

portfolio returns for the pre-regulation period (Pre-reg), the post-regulation period (Post-reg),

and the difference between the two periods (Post − Pre). Panel A shows that risk-adjusted

19
returns of the hedge portfolio long in upward analyst forecast revision firms and short in

downward analyst forecast revision firms (UR − DR) decline from 1.13% pre-regulation to

0.41% post-regulation. The post- minus pre-regulation difference of −0.72% is significant (t

= −4.08). Panel B shows broadly similar results for the PEAD effect. Risk-adjusted returns of

the hedge portfolio long in the highest standardized unexpected earnings firms and short in

the lowest standardized unexpected earnings (SUE5 − SUE1) decline from 1.28% pre-

regulation to 0.40% post-regulation, with a significant post- minus pre-regulation difference

of −0.88% (t = −4.76). This indicates that after controlling for risk, mispricing effects

associated with analyst forecast revisions and earnings announcements fall significantly after

the regulations. In both cases, raw returns show a broadly similar pattern. These consistent

findings support hypothesis H1, which predicts a reduction in these mispricing effects after

the enactment of Reg FD, SOX, and other analyst regulations.

4.2. TESTS OF HYPOTHESIS H2

Table 3 presents a test of hypothesis H2 based on analyst forecast revision and PEAD

effects. Each panel partitions stocks by one of the eight information uncertainty proxies. For

the analyst forecast revision effect on the left of table 3, for example, panel A partitions firms

by information uncertainty based on accruals quality (AQ). In this case, risk-adjusted returns

of the hedge portfolio long in upward revision firms and short in downward revision firms

(UR − DR) during the pre-regulation period are 1.44% (t = 8.26) in the highest information

uncertainty group (IU5) and 0.35% (t = 1.91) in the lowest information uncertainty group

(IU1). The difference in hedge portfolio returns between these two groups (IU5 − IU1) is a

significant 1.09% (t = 4.65). The same positive relation between the analyst forecast revision

effect and firms’ information uncertainty holds for all eight panels, matching the results of

Gleason and Lee [2003] and Zhang [2006]. Post-regulation, the mispricing effect based on

AQ falls to 0.35% (t = 2.14) in the highest information uncertainty group and the post- minus

pre-regulation difference of −1.09% is significant (t = −4.57). In contrast, the lowest

20
information uncertainty group has an insignificant change in the mispricing effect of −0.06%

(t = −0.22). The difference-in-differences (post- minus pre-regulation of IU5 − IU1) estimate

is −1.03% (t = −3.06). This shows that the mispricing effect in the high information

uncertainty group converges towards the level for the low information uncertainty group,

supporting hypothesis H2 and consistent with figure 1. The other seven panels provide

consistent difference-in-differences results for the analyst forecast revision effect.

The right half of table 3 tests hypothesis H2 based on the PEAD effect. To illustrate our

results, we again refer to information uncertainty proxied by AQ in panel A. Risk-adjusted

returns of the hedge portfolio long in the highest standardized unexpected earnings firms and

short in the lowest standardized unexpected earnings firms (SUE5 − SUE1) during the pre-

regulation period are 1.69% (t = 8.22) in the highest information uncertainty group (IU5) and

0.78% (t = 3.32) in the lowest information uncertainty group (IU1), with a significant

difference of 0.90% (t = 2.87). This positive association between the PEAD effect and firms’

information uncertainty is consistent across seven of eight panels and is in line with the

findings of Francis et al. [2007]. In the post-regulation period, the same mispricing effect

falls to insignificant levels of 0.23% (t = 1.13) and 0.17% (t = 0.80) in the highest and lowest

information uncertainty groups, with an insignificant difference of 0.07% (t = 0.24). The

difference-in-differences estimate is a significant −0.84% (t = −1.99). This again supports

hypothesis H2 and is consistent with figure 1. Across the panels, the difference-in-differences

results for the PEAD effect are significant for seven of eight information uncertainty proxies.

Table 3 gives 16 difference-in-differences tests based on risk-adjusted returns for

combinations of two security mispricing effects and eight information uncertainty proxies, of

which 15 give significant evidence supporting hypothesis H2. While individual news or

information uncertainty proxies may be subject to noise or idiosyncracies, the high

consistency of our results provides robust evidence supporting our inferences. Figure 2

(based on table 3, panel H) illustrates our results. Panels A and B depict changes in analyst

21
forecast revision and PEAD effects respectively, conditional on the aggregate information

uncertainty measure. In panel A, the highest and lowest information uncertainty groups are

associated with hedge portfolio returns of 1.55% and 0.21% in the pre-regulation period and

0.22% and −0.09% in the post-regulation period for the analyst forecast revision effect. The

decline is statistically significant in the highest information uncertainty group (−1.32%, t =

−5.74) but not in the lowest information uncertainty group (−0.30%, t = −1.14). Panel B

shows broadly similar patterns for the PEAD effect. Both mispricing effects therefore mirror

scenario 2 for the highest information uncertainty group and scenario 3 for the lowest

information uncertainty group in figure 1, consistent with hypothesis H2.

4.3. ADDITIONAL TESTS

This section reports findings from an exhaustive series of additional tests to check the

robustness of our results to alternative explanations.

4.3.1. Time trend and trading activities. To determine whether a time trend or investor

trading activity might explain our findings, we re-examine the results supporting hypothesis

H2 using the following time-series regression:

RHIU t  1   2 Postt   3 RLIU t   4 MKTt   5 SMBt   6 HMLt   7UMDt

(2)
 8Timet   9Timet2  10 ΔHOhmlt  11ΔIOhmlt  12 ΔTOhmlt   t

where for each month t, the dependent variable (RHIU) is the return of the hedge portfolio

(i.e., either UR – DR for the analyst forecast revision effect or SUE5 – SUE1 for the PEAD

effect) based on firms in the highest information uncertainty quintile (IU5), Post is an

indicator taking the value 1 for post-regulation months and 0 for pre-regulation months, and

RLIU is the return of the corresponding hedge portfolio based on firms in the lowest

information uncertainty quintile (IU1). MKT, SMB, HML, and UMD are the four Fama and

French [1996] and Carhart [1997] factors defined in equation (1). Time begins at 0.01 and

increases by 0.01 per month over the sample period and Time2 is the square of Time.

HOhml, IOhml, and TOhml are the return spreads between firms with the top and bottom

22
30% changes in hedge fund ownership, institutional investor ownership, and share turnover

respectively (see the appendix for detailed descriptions of all variables). A negative

coefficient on Post indicates that the hedge portfolio return of the highest information

uncertainty quintile declines in the post-regulation period. RLIU controls for unidentified

common factors that could affect the return predictability of the same news proxy across all

stocks. The Fama–French–Carhart factors control for systematic risk. Time and Time2 control

for any linear and non-linear time trends. IOhml, HOhml, and TOhml control for return

patterns associated with trading activities of hedge funds, institutional investors, and

investors in general.

Table 4 presents our findings. In panel A the dependent variable is the monthly return of

a hedge portfolio long in upward analyst forecast revision firms and short in downward

analyst forecast revision firms (UR − DR) within the highest information uncertainty quintile

(IU5). In panel B the dependent variable is the monthly return of a hedge portfolio long in the

highest standardized unexpected earnings firms and short in the lowest standardized

unexpected earnings firms (SUE5 − SUE1) in the highest information uncertainty quintile

(IU5). To capture information uncertainty, we use the aggregate measure that combines the

joint effect of seven individual proxies, namely accruals quality, firm size, firm age, analyst

coverage and forecast dispersion, and cash flow and stock return volatility. In model 4, for

example, the coefficient on Post is significantly negative in panels A (−1.52, t = −2.54) and B

(−1.86, t = −2.97). This confirms that the greater post-regulation reduction in both mispricing

effects among high information uncertainty firms in table 3 is not subsumed by a linear or

non-linear time trend or by return variation associated with changes in hedge fund ownership,

institutional ownership, or share turnover. In contrast, the coefficients on the two time trend

variables give mixed evidence, with the hedge portfolio returns being positively associated

with the linear time trend in the case of the analyst forecast revision effect but being

insignificant for the PEAD effect, and the non-linear time trend being insignificant for both

23
mispricing effects. For the trading activity controls, there is no association of the mispricing

effects with HOhml, IOhml, or TOhml.3 These findings show that although hedge fund

ownership, institutional ownership, and share turnover increase from pre- to post-regulation,

as table 1 shows, these increases do not explain our main findings. In other words, table 4

confirms that our findings in table 3 are not due to a time trend or investor trading activity.

4.3.2. Changes in the corporate information environment. To confirm that higher

information uncertainty firms experienced a greater improvement in their corporate

information environment than their lower information uncertainty counterparts, we conduct

the following analysis. We use analyst forecast accuracy to proxy for the quality of the

corporate information environment, as it directly captures analyst reporting decisions and is

indirectly affected by mandated and voluntary firm disclosures. We compare the highest

(IU5) and lowest (IU1) information uncertainty quintile portfolios and estimate the following

panel regression based on portfolio–month observations:

FAp ,t  γ1  γ2 Post p ,t  γ3 HIU p ,t 1  γ4 Post p ,t  HIU p ,t 1  γ5Time p ,t  γ6Time p ,t  HIU p ,t 1

 γ7Time 2p ,t  γ8Time 2p ,t  HIU p ,t 1  γ9 HO p ,t  γ10 HO p ,t  HIU p ,t 1 (3)
 γ11 IO p ,t  γ12 IO p ,t  HIU p ,t 1  γ13TO p ,t  γ14TO p ,t  HIU p.t 1  ε p ,t

where for quintile portfolio p in month t, FA is average analyst forecast accuracy, HIU takes

the value 1 for the highest information uncertainty quintile IU5 and 0 for the lowest

information uncertainty quintile IU1, HO is the average level of hedge fund ownership, IO is

the average level of institutional ownership, TO is the average level of share turnover, and all

other variables are as defined in equation (2). The coefficient on HIU estimates the pre-

regulation difference in analyst forecast accuracy between the highest and lowest information

uncertainty quintiles. The coefficient on Post × HIU indicates the difference in the pre- to

post-regulation forecast accuracy changes between these extreme information uncertainty

quintiles. A positive coefficient indicates that high information uncertainty firms experience a

                                                            
3
We obtain similar findings when we include HOhml, IOhml, and TOhml in the regressions one at a time.

24
greater increase in analyst forecast accuracy following the regulations than low information

uncertainty firms.

Table 5 presents our findings. To capture information uncertainty, we use the

aggregate measure of the seven individual proxies. Throughout the table, the coefficient on

the interaction term Post  HIU is significantly positive. For instance, in model 3 it is 1.64 (t

= 6.54). This evidence supports our argument that the greater post-regulation reduction in

security mispricing among higher information uncertainty firms in table 3 is attributable to an

improved corporate information environment.

4.3.3. Short-term regulatory impact. To further substantiate our inference that the

increased market efficiency we observe is attributable to the regulations, we conduct the

following analysis to draw a direct link between the short-term regulatory impact on the

corporate information environment and the post-regulation reduction in stock mispricing. For

individual regulations or pairs of contemporaneous regulations, we adapt the approach of

Byard, Li, and Yu [2011] and calculate the short-term change in analyst earnings forecast

accuracy for each firm from the last fiscal year before to the first fiscal year after the

enactment.4 This short-term analyst forecast accuracy change captures the immediate effect

of the regulations on the ability of end-users of financial statement information to anticipate

future firm performance. We average the short-term forecast accuracy changes across

regulations into a combined measure denoted ΔSFA. We sort the 2,496 stocks by available

SFA into quintile portfolios, and observe post-regulation changes in mispricing across these

quintiles. This procedure essentially replaces the information uncertainty proxies we use as

conditioning variables in the main tests with a new measure that directly captures the
                                                            
4
For instance, we calculate the short-term forecast accuracy change around Reg FD (enacted in October 2000)
for a firm with a fiscal year ending in December as follows. We calculate the mean monthly earnings forecast
accuracy for the fiscal year ending in December, 1999 (December, 2001) as the short-term forecast accuracy
before (after) Reg FD. The difference from before to after Reg FD is the short-term forecast accuracy change
around Reg FD. Similarly, we calculate the short-term forecast accuracy change around SOX (enacted in July
2002), around the amended NYSE Rule 472 and NASD Rule 2711 (enacted in phases from July to November
2002), and around the Global Research Analyst Settlement and Regulation Analyst Certificate (effective in
April 2003). For the regulations enacted contemporaneously, we count the short-term forecast accuracy change
once.

25
regulatory effect on the corporate information environment. If the regulations directly

reduced mispricing, we expect the post-regulation decline in mispricing effects to be greater

among stocks in the highest SFA quintile. If we do not observe a greater post-regulation

reduction in mispricing among stocks in the highest SFA quintile, there could be two

explanations. First, the effect of the regulations on mispricing occurs over a longer period.

Second, the regulations do not reduce mispricing, and what we observe is due to some

unidentified confounding effects.

Table 6 presents our findings. The difference between firms in the highest and lowest

SFA quintiles in terms of the post- minus pre-regulation period analyst forecast revision

effect is −0.94% (t = −2.15) and the PEAD effect is −0.88% (t = −1.73). In table 3, panel H,

the difference between firms with the highest and lowest aggregate information uncertainty in

terms of the post- minus pre-regulation period analyst forecast revision effect is −1.02% and

the PEAD effect is −1.35%, both statistically significant. Thus, the post-regulation reductions

in the analyst forecast revision and PEAD effects immediately around the enactment of the

regulations, based on short-run changes in analyst forecast accuracy, are respectively 92%

( 0.94 1.02 ) and 65% ( 0.88 1.35 ) of the corresponding reductions based on the

aggregate information uncertainty measure in table 3, panel H. The results in table 6 further

support our finding that the regulations strengthened the corporate information environment

by improving the ability of investors to anticipate future firm performance, which in turn

reduced security mispricing.

4.3.4. Sensitivity tests. Table 7 presents findings from additional analyses to evaluate

whether our main findings are sensitive to various effects including the influence of the

recent financial crisis (Panel A), shorter pre- and post- regulation periods (Panel B), changes

in analyst coverage or firm delistings (Panel C), and changes in the values of the information

uncertainty proxies (Panel D). For brevity, in each case we report the mispricing effect

differences between the pre- and post-regulation periods for the top and bottom quintiles, and

26
the differences between these quintiles, based on the aggregate information uncertainty

measure.

To examine whether the recent financial crisis affects our findings, we exclude

04/2007–12/2011 from the post-regulation period. We define the beginning of the crisis as

the second quarter of 2007, following Ryan [2008]. Table 7, panel A confirms that excluding

the crisis period does not affect our conclusions. The difference across the highest and lowest

information uncertainty quintiles in terms of the differences between the post- (05/2003–

03/2007) and pre-regulation (01/1983–09/2000) periods is −0.88% (t = −2.24) for the analyst

forecast revision effect and −1.62% (t = −3.23) for the PEAD effect.

To examine whether our results concentrate around the time of the regulations, we

examine changes in the analyst forecast revision and PEAD effects using late pre-regulation

(01/1992–09/2000) and early post-regulation (05/2003–03/2007) sub-periods. Consistent with

our main findings, table 7, panel B indicates that the reductions in both mispricing effects are

significantly more pronounced among greater information uncertainty firms. Specifically, the

difference-in-differences estimates is −1.07% (t = −2.44) based on the analyst forecast

revision effect and −1.41% (t = −2.38) for the PEAD effect.

To examine whether firms that had no analyst coverage or firms delisted during the

post-regulation period affect our findings, we limit our sample to firms listed and followed by

analysts both pre- and post-regulation. Firms that lose analyst coverage or delist are likely to

have greater information uncertainty and mispricing effects, which may bias our results in

favor of our hypotheses. The results of table 7, panel C confirm that these factors do not

affect our inferences. The difference-in-differences estimates for the analyst forecast revision

and PEAD effects are both statistically significant (−0.78%, t = −2.41 and −1.46%, t = −3.73).

Changes in the values of our information uncertainty measures from pre- to post-

regulation might affect our results. This can occur for two reasons. First, to the extent the

regulations affected firm behavior, this may have affected some of our information

27
uncertainty measures. In other words, information uncertainty proxies such as accruals

quality are partly the outcome of managerial decision making that the regulatory changes

may influence. Second, firm-specific information uncertainty proxies, such as firm size, may

change over time. Some firms may have experienced an increase in market efficiency even

without a regulatory effect.

To control for the effect of the regulations on our information uncertainty proxies, we

divide firms into quintiles based on aggregate information uncertainty measures estimated

one year before the regulatory transition period (October 1999 to September 2000). This

means we compare changes in mispricing for the same set of firms within each information

uncertainty quintile from the pre- to post-regulation. Table 7, panel D presents the results of

this analysis, which are consistent with our main findings. The difference-in-differences

estimates for the analyst forecast revision and PEAD effects are −1.17% (t = −2.41) and

−2.45% (t = −4.31).

Finally, to address the effect of temporal changes in the information uncertainty

proxies, we replicate our analysis in table 3 by redefining each of the individual information

uncertainty quintile breakpoints based on the overall sample period. Untabulated results show

that our findings are not sensitive to the way we define information uncertainty quintile

breakpoints.

 4.3.5. Tests using European listed firms. To show that the post-regulation reduction in

market inefficiency we observe is not driven by an unidentified factor not specific to U.S.

capital markets, we compare changes in mispricing for U.S. versus European listed firms.

European listed firms were not exposed to the disclosure and analyst regulations enacted in

the U.S. and can serve as a control sample for the treatment effect pertaining to the U.S.

regulatory changes we examine. We construct a European sample based on firms listed in 16

countries (Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, the

Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, and the United Kingdom). We

28
compare, separately in the U.S. and European samples, the abnormal return predictability of

analyst forecast revisions conditional on the aggregate information uncertainty measure over

two time periods, from January 1991 to September 2000 and from May 2003 to December

2011.5

Table 8 presents our findings. Among European listed firms, the abnormal return

predictability of analyst forecast revisions is significantly greater among firms with higher

information uncertainty in both time periods, and there is no significant difference in the

effect between the two periods. For instance, the difference between the high and low

information uncertainty quintiles in terms of the analyst forecast revision effect is 0.98% (t =

2.17) in the first period and 1.27% (t = 5.06) in the second period, with a difference of 0.30%

(t = 0.58). This indicates evidence of market inefficiency in both periods with no reduction

through time. Among U.S. listed firms, the abnormal return predictability of analyst forecast

revisions is significantly greater among higher information uncertainty firms only in the

former (1.49%, t = 5.35) but not the latter (0.32%, t = 1.49) time period and the difference is

significant (−1.17%, t = −3.35). This indicates that there is a significant reduction in market

inefficiency between the two periods. The difference between the U.S. and European samples

in terms of the reduction in abnormal return predictability of analyst forecast revisions is also

significant (−1.47%, t = −2.36).

This additional analysis shows that a significant reduction in market inefficiency

occurred following the U.S. regulations among U.S. listed firms but not among European

listed firms over comparable periods. This evidence further strengthens our inference that the

U.S. regulatory changes contributed to the improved informational efficiency of U.S. capital

markets.

                                                            
5
The first period is shorter than the pre-regulation period in our main test due to the limited availability of
analyst forecast data for the European listed firm sample. We use the same sample period for U.S. and European
listed firms to ensure comparability. We focus on the analyst forecast revision effect as European firms report
earnings at a lower frequency than U.S. firms, reducing the power of PEAD tests.

29
 4.3.6. A regression discontinuity design to identify the regulatory effect. To further

support our identification of the impact of regulatory change per se, we compare the PEAD

effect for firms that were just above and below the SOX Section 404 compliance cutoff.6

Section 404 required listed firms with a public float exceeding $75 million in 2002, 2003, and

2004 to file a management report (MR) and provide independent auditor attestation of this

report for fiscal years ending on or after November 15, 2004. 7 The MR provides an

assessment of the design and operating effectiveness of internal control. Firms below the

public float threshold were exempt from Section 404 for MRs until 2007 and for auditor

assessments until 2010. Iliev [2010] argues that these firms serve as a quasi-natural control

group for empirical studies of SOX, to isolate potential confounding effects such as

concurrent changes in the financial, economic, and political environment (Coates [2007];

Leuz [2007]). Using a regression discontinuity design, Iliev [2010] compares firms close to

the Section 404 cutoff, i.e., with a public float between $50 and $100 million, and finds

significant differences in audit fees and earnings quality between MR filers and non-filers for

the first fiscal year ending on or after November 15, 2004.

We apply Iliev’s [2010] regression discontinuity design to examine the PEAD effect.8

We confine our sample to firms that reported a public float between $50 and $100 million in

fiscal year 2004, and implement the following cross-sectional regression for the first fiscal

year ending on or after November 15, 2004:

CARi  α0  a1SUERi  a2 MRi  a3MRi  SUERi  a4 MVi  a5 BMi  a6 MOMi

(4)
a7 PFLi  a8 PFL2i  a8 PFL3i  εi

where CAR is cumulative abnormal return, calculated as cumulative daily return adjusted by

the value-weighted market return for the 60-trading days following the earnings
                                                            
6
We focus on PEAD as a mispricing indicator since there is limited analyst coverage of the small firms in this
analysis. The limited analyst coverage also means we focus on SOX instead of other analyst related regulations.
7
Public float is the part of equity not held by management or larger shareholders, as reported on the first page of
the company 10K filings. Iliev [2010] gives a detailed discussion of the definition of public float. The
management report and public float data we apply in this analysis were kindly provided by Peter Iliev.
8
Roberts and Whited [2012] also suggests regression discontinuity design is a useful method to address
endogeneity problem.

30
announcement; MR equals 1 for firms that filed an MR, and 0 otherwise; SUER is ranked

standardized unexpected earnings, measured as the difference between the earnings of the

fourth fiscal quarter and the same quarter in the previous year scaled by the fourth fiscal

quarter end share price, and ranked by  n  1  N  1 , where n is the standardized

unexpected earnings rank and N is the total number of observations; MV is the log of market

value, calculated as share price times shares outstanding at the fiscal year end; BM is total

common equity over market value at the fiscal year end; MOM is the compounded past 11

months’ stock return ending one month before the earnings announcement; and PFL is the

public float in the second quarter of fiscal year 2004.

Following Iliev [2010], we also control for the possibility that firms manipulate public

floats to avoid compliance using instrumental variables (IV):

MRi   0   1 PF 75 2002 i   2 MVi   3 BM i   4 MOM i   5 PFLi   6 PFL2i   7 PFL3i   i

(5)
CAR     SUER   MR    MR   SUER   MV   BM   MOM  
i 0 1 i 2 i 3 i i 4 i 5 i 6 i i

where PF 752002 equals 1 if firms had a public float over $75 million in fiscal year 2002, and

0 otherwise. Since the SEC announced the Section 404 compliance rule cutoff of $75 million

in June 5, 2003, firms may have manipulated their public float for 2003 and 2004 but had no


chance to do this in 2002. Thus, we use PF 752002 to instrument for filing an MR in 2004. MR

is the fitted value from the first-stage regression using a linear probability model following

Iliev [2010]. Other variables are defined in equation (4).

Table 9 presents the results, with panel A giving summary statistics for the variables

and panel B reporting the regression results. The coefficient on SUER is significantly positive

throughout panel B: 0.27 (t = 2.89) for OLS and 0.25 (t = 2.15) for IV approach. This

suggests a significant PEAD effect among firm exempt under SOX Section 404 from filing

MRs. In contrast, the coefficient on MR  SUER is significantly negative throughout panel B,

with corresponding estimates of −0.38 (t = −2.83) and −0.43 (t = −1.98). This indicates that

31
firms required to file MRs under Section 404 were associated with a significantly lower

PEAD effect relative to non-filing counterparts that should have been similarly affected by

concurrent changes in financial, economic, and political environment. This is broadly in line

with the finding of improved earnings quality of Iliev [2010]. Although evidence from this

analysis applies to a specific SOX requirement, it allows us to focus on the detailed effect of

one of the main disclosure regulations enacted over the period we examine, and strengthens

the inference from our main findings that these regulatory changes increased stock market

efficiency.

5. Conclusion

The efficient allocation of financial resources is a primary function of capital markets.

Corporate transparency and investor confidence are essential for capital markets to serve this

function well. A series of regulations were enacted between 2000 and 2003 in U.S. capital

markets aimed at improving the corporate information environment. The scale and stringency

of these reforms invite important questions of interest to practitioners, academics, and

regulators. For instance, did these regulations reduce analyst bias and improve firm

disclosures? Were the regulations socially beneficial to the extent that they improved security

valuation by investors? The literature mainly answers the former question by examining the

impact of the regulations on the suppliers of financial information. Unlike these studies, we

address the latter question by examining the effect of the regulations on the end-users of

financial information.

After the enactment of these regulations, we find a significant decline in security

mispricing based on the analyst forecast revision and post-earnings announcement drift

effects. These reductions occurred mainly in higher information uncertainty firms, consistent

with an improved corporate information environment having greater benefits for investor

valuations of firms with future earnings that are more difficult to predict. Our findings are

32
robust to potential confounding effects such as temporal effects, investor trading activity, the

recent financial crisis, changes in analyst coverage, delistings, and changes in the values of

the information uncertainty proxies. We reinforce our inference that the regulatory changes

increased market efficiency through improving the corporate information environment by

showing that a significantly greater increase in analyst forecast accuracy occurred among

firms with higher information uncertainty. To draw a more direct link between the regulations

and changes in market efficiency, we show that the reduced mispricing effects were

associated with cross-sectional variation in short-term analyst forecast accuracy changes

immediately around the enactment of the regulations. We demonstrate that the increased

market efficiency experienced in U.S. markets did not occur in European listed firms that

were not exposed to the U.S. regulatory changes. Finally, we apply a regression discontinuity

design to show that the level of mispricing was significantly lower among firms that SOX

Section 404 required to file additional disclosures than among firms that were exempt from

doing so.

We believe we have controlled for the most influential alternative explanations of our

findings. While we cannot completely rule out other effects, we believe they are unlikely to

be pervasive or systematic enough to compete with the effect of the regulations. Of course,

there are limitations in the ability of empirical studies based on analyses of large sample

archival data to identify the exact and specific underlying regulatory mechanisms or

components that affect market-based variables such as bid-ask spread, liquidity, cost of

capital, and stock returns. Future research may use alternative approaches such as surveys,

interviews, or case studies. However, these methodologies have their own limitations

including the generalizability of their results. Our study belongs to an extensive and well-

established literature that seeks to verify the cost and benefit of disclosure regulations, such

as SOX or International Financial Reporting Standards (IFRS), for capital markets.

33
 Despite the ongoing debate on the pros and cons of regulating corporate disclosure and

the costs of such interventions, our evidence suggests that the regulations we examine

improved the informational efficiency of U.S. capital markets. This supports the argument

that regulatory intervention to improve the quality of the corporate information environment

can benefit investors (Jolls, Sustein, and Thaler [1998], Brav and Heaton [2002], Chan, Lee,

and Lin [2009]). Besides informing the continuing debate on these regulations, our evidence

highlights the role of the supply side of financial information in stock return anomalies, while

the focus of this issue in the market efficiency literature is mainly on the cognitive biases of

investors on the demand side of financial information.

A final caveat is that our evidence does not imply that regulation can solve all problems

associated with the corporate information environment. First, regulatory effectiveness

ultimately depends on the degree of enforcement (Holthausen [2009]). For instance, Lang,

Ready, and Wilson [2006] report lower earnings quality among foreign firms cross-listed in

the U.S., despite their reporting under U.S. GAAP, and argue that this could be due to a lower

standard of regulatory enforcement on these firms. Second, market forces and firms’

disclosure incentives are pivotal in determining corporate transparency, both in isolation and

in interaction with regulation (Leuz and Wysocki [2008]). For instance, studies in the context

of international accounting highlight the importance of firms’ financial reporting incentives

over accounting standards in determining accounting information quality (Ball, Kothari, and

Robin [2000], Leuz, Nanda, and Wysocki [2003], Christensen, Lee, and Walker [2008]).

Finally, the primary component of the corporate information environment is firms’ voluntary

disclosures since it is managers who have superior information about their firms, not

regulators or analysts. Regulation and analysts supplement but do not substitute for firms’

voluntary disclosure.

34
 APPENDIX
Variable Definitions
Variable Definition
AGE = Firm age: the number of years since a stock first lists on the CRSP daily file until the end of
the portfolio formation month.
Aggregate = Aggregate information uncertainty: the mean ranked value of seven information uncertainty
IU proxies (AQ, MV, AGE, COV, CVOL, DISP, and SIGMA). Ranked value is  n  1  N  1 ,
where n is the within-information uncertainty rank of each information uncertainty proxy and
N is the total number of observations.
AQ = Accruals quality: the standard deviation of residuals from cross-sectional regressions over the
past five years’ (minimum three years’) within Fama–French 48 industry groups of total
current accruals on past, current, and future cash flows, revenue changes, and PPE (Francis et
al. [2005]).
BM = Book-to-market ratio: total common equity over market value at the fiscal year-end.
CAR = Cumulative abnormal return: calculated as cumulative daily return adjusted by value-weighted
market return for the 60-trading days following the earnings announcement.
COV = Analyst coverage: the number of analysts following a firm in the previous calendar year.
CVOL = Cash flow volatility: standard deviation of the past five years’ (minimum three years’) cash
flow from operations. Cash flow from operations is earnings before extraordinary items minus
accruals, over average total assets. Accruals are changes in current assets minus changes in
cash, changes in current liabilities, and depreciation expense, plus changes in short-term debt.
DISP = Analyst forecast dispersion: standard deviation of analyst forecasts in the portfolio formation
month scaled by the book value of total assets (Johnson [2004]).
DR = Firms with downward analyst forecast revisions (REV < 0), i.e., the bad news group.
FA = Forecast accuracy: following Lang and Lundholm [1996], FA is the negative of the absolute
forecast error deflated by stock price, FAt   actual EPSt  forecast EPSt Pt , where actual EPS is
annual actual earnings, forecast EPS is the monthly earnings forecast, and P is share price at
the end of the previous year; winsorized at the bottom and top 1%.
HIU = A dummy variable equal to 1 for the highest information uncertainty quintile (IU5) and 0 for
the lowest information uncertainty quintile (IU1).
HML = The average return on the two value portfolios minus the average return on the two growth
portfolios, constructed using the six value-weighted portfolios formed on size and book-to-
market (Fama and French [1996]).
HO = Hedge fund ownership: total number of shares held by hedge funds divided by shares
outstanding at the end of each quarter, winsorized at the bottom and top 1%.
HOhml = The value-weighted average returns of firms with the top 30 percent hedge fund ownership
change minus the value-weighted average returns of firms with the bottom 30 percent hedge
fund ownership change.
IO = Institutional ownership: total number of shares held by institutional investors divided by shares
outstanding at the end of each quarter, winsorized at the bottom and top 1%.
IOhml = The value-weighted average returns of firms with the top 30 percent institutional ownership
change minus the value-weighted average returns of firms with the bottom 30 percent
institutional ownership change.
IU1 = Firms in the bottom quintile based on each of the seven information uncertainty proxies, i.e.,
the lowest information uncertainty group.
IU5 = Firms in the top quintile based on the each of the seven information uncertainty proxies, i.e.,
the highest information uncertainty group.
MV = The log of market value, measured as share price times shares outstanding at the end of the
portfolio formation month.
MKT = The value-weighted average return on all NYSE, AMEX, and NASDAQ stocks minus the one-
month Treasury bill rate (Fama and French [1996]).
MOM = The compound past 11 months’ stock returns ending one month before the earnings
announcement.
MR = Dummy variable equal to one if the firm filed a management report in 2004.
NR = Firms with zero analyst forecast revisions (REV = 0), i.e., the no news group.
PFL = Public float reported in the second quarter of fiscal year 2004.
PFL2 = The square of PFL.
PFL3 = The cube of PFL.
(Continued)

35
 APPENDIX—Continued
Variable Definition
PF752002 = Dummy variable equal to one for firms with public float greater than $75 million in 2002.
Post = A dummy variable equal to 1 for post-regulation (05/2003–12/2010) months and 0 for pre-
regulation (01/1983–09/2000) months.
REV = Forecast revision: mean monthly analyst forecast revision for a firm, where an individual
analyst forecast revision is the analyst earnings forecast in the portfolio formation month minus
the previous earnings forecast for the same fiscal year-end by the same analyst for the same
company, scaled by the previous fiscal year-end stock price. Good news, no news, and bad
news correspond to upward, zero, and downward revisions.
RHIU = For the analyst forecast revision effect, RHIU is the zero-cost hedge portfolio return of the
highest information uncertainty group (IU5) long in upward analyst forecast revision stocks
(UR) and short in downward analyst forecast revision stocks (DR). For the PEAD effect, RHIU
is the zero-cost hedge portfolio return of the highest information uncertainty group (IU5) long
in the highest standardized unexpected earnings stocks (SUE5) and short in the lowest
standardized unexpected earnings stocks (SUE1).
RLIU = For the analyst forecast revision effect, RLIU is the zero-cost hedge portfolio return of the
lowest information uncertainty group (IU1) long in upward analyst forecast revision stocks
(UR) and short in downward analyst forecast revision stocks (DR). For the PEAD effect, RLIU
is the zero-cost hedge portfolio return of the lowest information uncertainty group (IU1) long
in the highest standardized unexpected earnings stocks (SUE5) and short in the lowest
standardized unexpected earnings stocks (SUE1).
SFA = For individual regulations or pairs of contemporaneous regulations we consider, we calculate
the short-term change in analyst earnings forecast accuracy for each firm from the last fiscal
year before to the first fiscal year after the enactment. We average the short-term forecast
accuracy changes across regulations into a combined measure denoted SFA.
SFA1 = Firms in the bottom quintile based on SFA, i.e., firms that experience the lowest forecast
accuracy improvement immediately around the regulations.
SFA5 = Firms in the top quintile based on SFA, i.e., firms that experience the highest forecast
accuracy improvement immediately around the regulations.
SIGMA = Return volatility, standard deviation of weekly market excess returns during the year ending at
the end of the portfolio formation month, where weekly returns are compounded from
Wednesday to Wednesday to avoid nonsynchronous trading or bid–ask bounce effects in daily
prices (Lim [2001], Zhang [2006]).
SMB = The average return on the three small portfolios minus the average return on the three big
portfolios, constructed using six value-weighted portfolios formed on size and book-to-market
(Fama and French [1996]).
SUE = Standardized unexpected earnings: the difference between actual and forecast earnings scaled
by stock price, SUEt   actual EPSt  forecast EPSt  Pt , where actual EPS in month t is the firm’s
most recent quarterly actual earnings, forecast EPS is the median analyst earnings forecasts,
based on the last forecast made by each analyst before the earnings announcement, and P is
share price 20 days before the earnings announcement.
SUE1 = Firms in the bottom quintile based on the most recent standardized unexpected earnings, i.e.,
the bad news group.
SUE5 = Firms in the top quintile based on the most recent standardized unexpected earnings, i.e., the
good news group.
SUER = Ranked standardized unexpected earnings: measured as the difference between earnings of the
fourth fiscal quarter and the same quarter of the previous year scaled by the fourth fiscal
quarter end share price, and ranked by  n  1  N  1 , where n is the standardized unexpected
earnings rank and N is the total number of observations.
Time = Starts at 0.01 and increases by 0.01 each month over the sample period.
Time 2 = The square of Time.
TOhml = The value-weighted average returns of firms with the top 30 percent share turnover change
minus the value-weighted average returns of firms with the bottom 30 percent share turnover
change.
UMD = The equal-weighted average of returns of firms with the highest 30 percent eleven-month
returns lagged one month minus the equal-weighted average of returns of firms with the lowest
30 percent eleven-month returns lagged one month (Carhart [1997]).
UR = Firms with upward analyst forecast revisions (REV > 0), i.e., the good news group.

36
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47
 TABLE 1 
Descriptive Statistics
Panel A: Pre-regulation (01/1983–09/2000)
N Mean Standard deviation Q1 Median Q3
RET (%) 459,546 1.20 12.00 −5.21 0.80 7.14
REV (%) 427,060 −0.01 0.08 0.00 0.00 0.00
SUE(%) 292,997 −0.12 1.22 −0.13 0.01 0.15
AQ (%) 303,534 0.04 0.03 0.02 0.03 0.05
MV 459,546 1818.71 6074.43 113.80 331.06 1147.88
AGE 459,546 18.24 16.08 6.13 13.56 23.85
COV 443,471 10.59 9.78 4.00 7.00 15.00
DISP (%) 359,619 0.06 0.22 0.00 0.01 0.03
CVOL (%) 296,588 0.06 0.05 0.03 0.05 0.08
SIGMA (%) 459,546 5.17 2.47 3.37 4.61 6.38
Aggregate IU 221,777 0.50 0.21 0.34 0.51 0.66
FA (%) 420,712 −2.44 5.30 −2.20 −0.69 −0.21
HO (%) 459,546 3.54 4.06 0.46 2.21 5.15
IO (%) 459,546 40.29 21.35 23.22 39.65 56.62
TO 459,546 −3.62 11.04 −9.35 −6.73 −2.14
Panel B: Post-regulation (05/2003–12/2011)
N Mean Standard deviation Q1 Median Q3
RET (%) 235,834 0.86 11.44 −5.15 0.72 6.74
REV (%) 218,667 −0.01 0.12 0.00 0.00 0.00
SUE(%) 196,683 0.04 0.83 −0.04 0.05 0.21
AQ (%) 172,843 0.04 0.03 0.02 0.03 0.06
MV 235,834 4740.89 12910.71 342.43 916.69 2954.10
AGE 235,834 20.10 17.09 8.23 14.38 27.07
COV 232,787 10.86 8.14 5.00 9.00 15.00
DISP (%) 197,944 0.02 0.05 0.00 0.00 0.01
CVOL (%) 166,010 0.08 0.07 0.03 0.05 0.09
SIGMA (%) 235,834 4.96 2.48 3.18 4.44 6.14
Aggregate IU 135,049 0.50 0.20 0.35 0.51 0.66
FA (%) 195,811 −1.53 4.13 −1.23 −0.40 −0.13
HO (%) 235,834 12.20 7.04 7.20 11.24 16.43
IO (%) 235,834 68.64 25.66 52.99 73.51 87.42
TO 235,834 7.57 18.74 −4.48 2.64 13.62
RET is the one-month holding period stock return in month t. REV is the mean monthly analyst forecast revision for each firm, where an
individual forecast revision is the earnings forecast made by an analyst in month t−1 minus the previous earnings forecast made for the same
fiscal year-end by the same analyst scaled by the previous fiscal year-end stock price. SUE is the standardized unexpected earnings for
month t−1, measured as the difference between the most recent quarterly actual earnings as of month t−1 and the analyst earnings forecast
scaled by the share price 20 days before the earnings announcement. AQ is accruals quality, measured as the standard deviation of residuals
from cross-sectional regressions over the past five years’ (minimum three years’) within Fama–French 48 industry groups of total current
accruals on past, current, and future cash flows, revenue changes, and PPE (Francis et al. [2005]). MV is market value (in millions),
calculated as share price times shares outstanding at the end of month t−1. AGE is the number of years since a stock first lists on the CRSP
daily file until the end of month t−1. COV is analyst coverage, which is the number of analysts following a firm in the previous calendar
year. DISP is analyst forecast dispersion, defined as the standard deviation of analyst forecasts in month t−1 scaled by the book value of total
asset. CVOL is cash flow volatility, which is the standard deviation of the past five years’ (minimum three years’) cash flow from operations,
where cash flow from operations is earnings before extraordinary items minus accruals, over average total assets; accruals are changes in
current assets minus changes in cash, changes in current liabilities, and depreciation expense, plus changes in short-term debt. SIGMA is the
standard deviation of weekly market excess returns over the year ending at the end of month t−1. Aggregate IU is the aggregate information
uncertainty measure based on the average ranking of the seven individual information uncertainty proxies.  FA is monthly forecast accuracy
(in percentage), which is the negative of the absolute difference between the monthly earnings forecast and annual actual earnings scaled by
share price at the end of the previous year. HO is quarterly hedge fund ownership (the number of shares held by hedge funds divided by total
shares outstanding). IO is quarterly institutional ownership (the number of shares held by institutional investors divided by total shares
outstanding). TO is monthly share turnover (shares traded divided by shares outstanding), demeaned by the relevant stock exchange average
for NYSE/AMEX and NASDAQ over the sample period to make it comparable across exchanges (Chen, Hong, and Stein [2002]). The pre-
and post-regulation periods cover January 1983 to September 2000 and May 2003 to December 2011.

48
  
TABLE 2
Changes in the Analyst Forecast Revision and   Post-Earnings Announcement Drift Effects
Panel A: Portfolio returns by analyst forecast revisions
Raw returns Risk-adjusted returns
Pre-reg Post-reg Post − Pre Pre-reg Post-reg Post − Pre
* *** *
DR 0.67 0.82 0.15 −0.45 −0.17 0.28**
(1.93) (1.34) (0.22) (−5.53) (−1.89) (2.25)
NR 1.33*** 0.89 −0.44 0.08 −0.06 −0.14
(4.04) (1.62) (−0.68) (1.01) (−0.71) (−1.22)
*** ** *** **
UR 1.98 1.13 −0.85 0.68 0.24 −0.44***
(5.75) (2.07) (−1.32) (6.51) (2.49) (−3.14)
UR − DR 1.31*** 0.31* −1.00*** 1.13*** 0.41*** −0.72***
(10.74) (1.74) (−4.62) (10.56) (2.92) (−4.08)
Panel B: Portfolio returns by standardized unexpected earnings
Raw returns Risk-adjusted returns
Pre-reg Post-reg Post − Pre Pre-reg Post-reg Post − Pre
SUE1 0.56 0.72 0.16 −0.46*** −0.31*** 0.15
(1.53) (1.15) (0.23) (−5.38) (−2.90) (1.10)
SUE2 0.79** 0.79 −0.00 −0.29*** −0.09 0.20
(2.33) (1.50) (−0.00) (−2.64) (−0.97) (1.39)
SUE3 1.18*** 0.82 −0.36 −0.07 −0.05 0.02
(3.29) (1.56) (−0.57) (−0.71) (−0.55) (0.20)
SUE4 1.67*** 0.95* −0.72 0.45*** 0.01 −0.44***
(4.62) (1.70) (−1.08) (4.13) (0.18) (−3.42)
SUE5 2.02*** 1.16* −0.86 0.82*** 0.09 −0.73***
(5.67) (1.80) (−1.17) (8.01) (1.24) (−5.88)
*** *** *** *** ***
SUE5 − SUE1 1.46 0.44 −1.02 1.28 0.40 −0.88***
(13.58) (2.66) (−5.25) (10.40) (2.89) (−4.76)
The table reports changes in the analyst forecast revision and PEAD effects based on raw and risk-adjusted returns. We estimate
the risk-adjusted returns as the intercepts from regressions of monthly portfolio excess returns on the Fama–French–Carhart four
factor model:
Rt  Rft  α  βMKTt  sSMBt  hHMLt  uUMDt  εt
where R  Rf is portfolio excess return and the four factors are defined in Fama and French [1996] and Carhart [1997]. For the
analyst forecast revision effect, at the end of each month t−1, we divide stocks into three groups based on the sign of analyst
forecast revisions, i.e., upward analyst forecast revisions (UR), zero analyst forecast revisions (NR), and downward analyst
forecast revisions (DR). UR − DR is a zero-investment portfolio long in upward analyst forecast revision stocks and short in
downward analyst forecast revision stocks. Analyst forecast revision is the mean monthly analyst forecast revision for each firm,
where an individual forecast revision is the earnings forecast made by an analyst in month t−1 minus the previous earnings
forecast made for the same fiscal year-end by the same analyst scaled by the previous fiscal year-end stock price. For the PEAD
effect, at the end of month t−1, we sort stocks into quintile portfolios by standardized unexpected earnings using NYSE
breakpoints, with SUE5 comprising firms with the highest standardized unexpected earnings and SUE1 comprising firms with the
lowest standardized unexpected earnings. SUE5 − SUE1 is a zero-investment portfolio long in the highest standardized
unexpected earnings firms and short in the lowest standardized unexpected earnings firms. Standardized unexpected earnings for
month t−1 is the difference between the most recent quarterly actual earnings as of month t−1 and analyst earnings forecast scaled
by the share price 20 days before the earnings announcement. Portfolios are held for one month and portfolio returns are equally
weighted. The pre- and post-regulation periods cover January 1983 to September 2000 and May 2003 to December 2011. The t-
statistics in parentheses are adjusted for heteroskedasticity; ***, **, and * indicate statistical significance at 1%, 5%, and 10%.

49
 TABLE 3

Changes in the Analyst Forecast Revision and Post-Earnings Announcement Drift Effects Conditional on Information Uncertainty Proxies
Analyst forecast revision effect (UR−DR) Post-earnings announcement drift effect (SUE5−SUE1)
Pre-regulation Post-regulation Post − Pre Pre-regulation Post-regulation Post − Pre
Panel A: AQ
IU1 (Lowest) 0.35* (1.91) 0.29 (1.40) −0.06 (−0.22) 0.78*** (3.32) 0.17 (0.80) −0.62** (−1.97)
IU2 0.87*** (4.45) 0.12 (0.64) −0.75*** (−2.73) 0.87*** (4.92) 0.43* (1.89) −0.45 (−1.56)
IU3 0.95*** (6.37) 0.11 (0.53) −0.84*** (−3.39) 0.92*** (4.01) 0.09 (0.38) −0.83** (−2.54)
IU4 1.29*** (7.58) 0.49** (2.56) −0.80*** (−3.15) 1.26*** (5.47) 0.06 (0.27) −1.20*** (−3.78)
IU5 (Highest) 1.44*** (8.26) 0.35** (2.14) −1.09*** (−4.57) 1.69*** (8.22) 0.23 (1.13) −1.45*** (−5.01)
IU5 − IU1 1.09*** (4.65) 0.06 (0.24) −1.03*** (−3.06) 0.90*** (2.87) 0.07 (0.24) −0.84** (−1.99)
Panel B:1/MV
IU1 (Lowest) 0.37** (2.25) 0.14 (0.78) −0.23 (−0.95) 0.14 (0.90) −0.14 (−0.75) −0.29 (−1.16)
IU2 0.58*** (3.67) 0.15 (0.79) −0.43* (−1.74) 0.43** (2.35) 0.22 (0.98) −0.21 (−0.73)
IU3 0.73*** (4.15) 0.11 (0.56) −0.63** (−2.44) 0.82*** (4.44) 0.00 (0.01) −0.82*** (−2.83)
IU4 0.91*** (5.12) 0.18 (0.94) −0.73*** (−2.81) 1.28*** (7.05) 0.21 (0.95) −1.07*** (−3.73)
IU5 (Highest) 1.76*** (12.99) 0.75*** (4.40) −1.02*** (−4.68) 1.93*** (9.96) 0.70*** (4.50) −1.23*** (−4.94)
IU5 − IU1 1.40*** (7.77) 0.61*** (3.41) −0.79*** (−3.11) 1.79*** (7.94) 0.85*** (4.20) −0.94*** (−3.12)
Panel C: 1/AGE
IU1 (Lowest) 0.35** (2.29) 0.19 (0.86) −0.16 (−0.59) 0.40** (2.08) −0.16 (−0.67) −0.55* (−1.84)
IU2a 0.59*** (3.37) 0.40 (1.56) −0.19 (−0.62) 0.59** (2.33) 0.40* (1.67) −0.19 (−0.53)
IU3 0.75*** (4.41) 0.23 (1.43) −0.51** (−2.19) 0.75*** (3.53) 0.50** (2.54) −0.25 (−0.86)
IU4 1.11*** (7.09) 0.39** (2.23) −0.72*** (−3.10) 1.08*** (5.07) 0.56*** (2.85) −0.52* (−1.81)
IU5 (Highest) 1.63*** (11.86) 0.59*** (3.65) −1.04*** (−4.91) 1.80*** (11.06) 0.27 (1.63) −1.52*** (−6.56)
IU5 − IU1 1.29*** (6.76) 0.40** (2.01) −0.89*** (−3.24) 1.40*** (5.62) 0.43 (1.58) −0.97*** (−2.65)
Panel D: COV
IU1 (Lowest) 0.24 (1.15) 0.11 (0.52) −0.13 (−0.46) 0.52** (2.17) 0.24 (1.00) −0.27 (−0.81)
IU2 0.72*** (4.23) 0.36 (1.61) −0.36 (−1.30) 0.50** (2.53) 0.19 (0.8) −0.31 (−1.01)
IU3 0.73*** (5.21) 0.28* (1.72) −0.45** (−2.06) 0.80*** (3.83) −0.19 (−0.94) −0.99*** (−3.40)
IU4 1.03*** (6.01) 0.30 (1.64) −0.73*** (−2.95) 1.53*** (8.27) 0.51** (2.5) −1.02*** (−3.72)
IU5 (Highest) 1.62*** (12.99) 0.64*** (3.61) −0.99*** (−4.59) 1.69*** (10.80) 0.62*** (3.9) −1.07*** (−4.81)
IU5 − IU1 1.39*** (6.05) 0.53*** (2.63) −0.85*** (−2.81) 1.18*** (4.73) 0.38 (1.54) −0.80** (−2.29)
Panel E: DISP
IU1 (Lowest) 0.41*** (3.17) 0.24 (1.45) −0.17 (−0.82) 0.55*** (3.5) 0.17 (0.76) −0.38 (−1.37)
IU2 0.40** (2.18) 0.03 (0.20) −0.37 (−1.51) 0.84*** (4.39) 0.45** (2.32) −0.39 (−1.41)
IU3 0.73*** (4.49) 0.31 (1.59) −0.42* (−1.67) 0.79*** (3.44) 0.53** (2.54) −0.26 (−0.84)
IU4 1.15*** (8.67) 0.18 (1.13) −0.97*** (−4.68) 1.29*** (6.83) 0.52** (2.03) −0.77** (−2.44)
IU5 (Highest) 1.71*** (11.50) 0.56*** (2.73) −1.15*** (−4.59) 1.70*** (8.43) −0.04 (−0.21) −1.73*** (−6.43)
IU5 − IU1 1.30*** (7.05) 0.32 (1.53) −0.98*** (−3.54) 1.14*** (4.40) −0.21 (−0.72) −1.35*** (−3.46)

(Continued)

50
 TABLE 3—Continued

Analyst forecast revision effect (UR−DR) Post-earnings announcement drift effect (SUE5−SUE1)
Pre-regulation Post-regulation Post − Pre Pre-regulation Post-regulation Post − Pre
Panel F: CVOL
IU1 (Lowest) 0.38** (2.09) 0.31* (1.76) −0.08 (−0.30) 1.10*** (5.08) 0.01 (0.04) −1.09*** (-3.72)
IU2 0.68*** (3.52) −0.03 (−0.16) −0.71*** (−2.79) 0.98*** (4.82) 0.12 (0.53) −0.85*** (-2.82)
IU3 1.04*** (6.00) 0.08 (0.38) −0.96*** (−3.56) 0.72*** (3.72) −0.25 (−1.15) −0.98*** (−3.33)
IU4 1.22*** (7.76) 0.13 (0.55) −1.09*** (−3.88) 1.12*** (5.18) 0.33 (1.53) −0.79*** (−2.61)
IU5 (Highest) 1.34*** (7.56) 0.43*** (2.65) −0.91*** (−3.82) 1.54*** (7.27) 0.47** (2.31) −1.06*** (−3.62)
IU5 − IU1 0.95*** (4.48) 0.12 (0.49) −0.83** (−2.59) 0.43 (1.43) 0.46* (1.81) 0.03 (0.08)
Panel G: SIGMA
IU1 (Lowest) 0.47*** (3.15) 0.08 (0.57) −0.40* (−1.95) 0.39** (2.05) 0.16 (1.16) −0.23 (−0.99)
IU2 0.48*** (4.02) 0.10 (0.63) −0.38* (−1.89) 0.69*** (4.51) 0.41** (2.42) −0.28 (−1.25)
IU3 1.07*** (8.01) 0.20 (1.32) −0.86*** (−4.26) 0.99*** (5.92) 0.29 (1.41) −0.69*** (−2.60)
IU4 0.98*** (5.79) 0.55*** (2.80) −0.44* (−1.69) 1.15*** (6.32) 0.64*** (3.28) −0.51* (−1.92)
IU5 (Highest) 1.59*** (9.79) 0.65*** (2.80) −0.94*** (−3.34) 1.90*** (9.01) 0.46** (2.06) −1.43*** (−4.67)
IU5 − IU1 1.12*** (5.35) 0.57** (2.46) −0.55* (−1.75) 1.50*** (5.26) 0.30 (1.33) −1.20*** (−3.29)
Panel H: Aggregate IU
IU1 (Lowest) 0.21 (1.22) −0.09 (−0.45) −0.30 (−1.14) 0.27* (1.71) 0.06 (0.32) −0.21 (−0.82)
IU2 0.48*** (3.34) 0.08 (0.44) −0.40* (−1.77) 0.32 (1.46) −0.26 (−1.22) −0.59* (−1.90)
IU3 0.94*** (4.91) 0.08 (0.41) −0.86*** (−3.24) 0.49** (2.16) −0.12 (−0.52) −0.61* (−1.85)
IU4 0.72*** (4.14) 0.42* (1.67) −0.30 (−1.00) 0.90*** (4.33) −0.05 (−0.19) −0.95*** (−2.92)
IU5 (Highest) 1.55*** (9.13) 0.22 (1.44) −1.32*** (−5.74) 1.84*** (7.66) 0.28 (1.50) −1.55*** (−5.09)
IU5 − IU1 1.33*** (6.54) 0.32 (1.49) −1.02*** (−3.46) 1.56*** (5.52) 0.22 (0.97) −1.35*** (−3.71)

The table reports the intercepts from regressions of monthly portfolio excess returns on the Fama–French–Carhart four factor model:
Rt  Rft  α  βMKTt  sSMBt  hHMLt  uUMDt  εt
where R  Rf is portfolio excess return and the four factors are defined in Fama and French [1996] and Carhart [1997]. For the analyst forecast revision effect, at the end of each
month t−1, we divide stocks into three groups based on the sign of analyst forecast revisions, i.e., upward analyst forecast revisions (UR), zero analyst forecast revisions (NR), and
downward analyst forecast revisions (DR). UR − DR is a zero-investment portfolio long in upward analyst forecast revision stocks and short in downward analyst forecast
revision stocks. Each analyst forecast revision group is divided into quintiles based on information uncertainty proxies using NYSE breakpoints. For the PEAD effect, at the end
of each month t−1, we sort stocks into quintiles based on the standardized unexpected earnings using NYSE breakpoints, within each quintile into quintiles based on information
uncertainty proxies using NYSE breakpoints. SUE1 is the portfolio of lowest standardized unexpected earnings, SUE5 of highest standardized unexpected earnings; SUE5 −
SUE1 is a zero-investment portfolio long in the highest standardized unexpected earnings firms and short in the lowest standardized unexpected earnings firms. IU5 is the highest
information uncertainty group and IU1 is the lowest information uncertainty group for all information uncertainty proxies. Analyst forecast revision is the mean monthly analyst
forecast revision for a firm, where an individual forecast revision is the earnings forecast made by an analyst in month t−1 minus the previous earnings forecast made for the same
fiscal year-end by the same analyst scaled by the previous fiscal year-end stock price. Standardized unexpected earnings is the difference between the most recent quarterly actual
earnings as of month t−1 and analyst earnings forecast scaled by share price 20 days before the earnings announcement. AQ is accruals quality, measured as the standard deviation
of residuals from cross-sectional regressions over the past five years’ (minimum three years’) within Fama–French 48 industry groups of total current accruals on past, current,
and future cash flows, revenue changes, and PPE (Francis et al. [2005]). MV is market value (in millions), calculated as share price times shares outstanding at the end of month
t−1. AGE is the number of years since a stock first lists on the CRSP daily file until the end of month t−1. COV is analyst coverage, which is the number of analysts following a
firm in the previous calendar year. DISP is analyst forecast dispersion, defined as the standard deviation of analyst forecasts in month t−1 scaled by book value of total asset.
CVOL is cash flow volatility, which is the standard deviation of the past five years’ (minimum three years’) cash flow from operations, where cash flow from operations is
earnings before extraordinary items minus accruals, over average total assets; accruals are changes in current assets minus changes in cash, changes in current liabilities, and
depreciation expense, plus changes in short-term debt. SIGMA is the standard deviation of weekly market excess returns over the year ending at the end of month t−1. Aggregate
IU is an aggregate information uncertainty measure based on the average ranking of the seven individual information uncertainty proxies. The pre- and post-regulation periods
span from January 1983 to September 2000 and May 2003 to December 2011. The t-statistics in parentheses are adjusted for heteroskedasticity; ***, **, and * indicate statistical
significance at 1%, 5%, and 10%.

51
 TABLE 4
Controlling for Time Trends and Trading Activity
Panel A: Analyst forecast revision effect Panel B: Post-earnings announcement drift effect
Model 1 Model 2 Model 3 Model 4 Model 1 Model 2 Model 3 Model 4
Intercept 1.59*** 1.48*** 0.76* 0.71* 1.89*** 1.76*** 1.56*** 1.54***
(8.61) (8.68) (1.73) (1.66) (8.95) (7.86) (3.07) (3.09)
Post −1.41*** −1.26*** −1.58*** −1.52** −1.60*** −1.47*** −1.88*** −1.86***
(−5.47) (−5.45) (−2.64) (−2.54) (−5.82) (−5.22) (−3.02) (−2.97)
RLIU 0.38*** 0.26*** 0.24** 0.25*** 0.25*** 0.21*** 0.21*** 0.20***
(3.49) (2.68) (2.49) (2.60) (3.82) (3.05) (3.09) (2.87)
MKT 0.04 0.03 0.04 0.07** 0.07** 0.07**
(1.36) (1.25) (1.45) (2.21) (2.19) (2.28)
SMB −0.06 −0.06 −0.08 −0.03 −0.03 −0.05
(−0.75) (−0.74) (−1.11) (−0.63) (−0.61) (−1.00)
HML −0.18*** −0.18*** −0.19*** −0.06 −0.06 −0.06
(−3.19) (−3.05) (−3.18) (−0.88) (−0.80) (−0.86)
UMD 0.17*** 0.17*** 0.15*** 0.08* 0.08* 0.06
(5.19) (5.13) (4.22) (1.90) (1.87) (1.36)
Time 1.00* 1.03* 0.16 0.19
(1.73) (1.80) (0.23) (0.27)
Time2 −0.23 −0.24 0.03 0.02
(−1.21) (−1.24) (0.14) (0.11)
HOhml 0.09 −0.04
(0.88) (−0.33)
IOhml 0.11 0.15
(1.29) (1.25)
TOhml 0.02 0.04
(0.25) (0.47)
Adj. R2 19.74% 33.83% 34.50% 34.91% 11.68% 13.95% 13.56% 13.34%
The table examines whether the fall in the price continuation effects in the highest information uncertainty group (RHIU) is robust to controlling
for confounding effects, using the regression:
RHIUt  δ1  δ2 Postt  δ3 RLIUt  δ4 MKTt  δ5SMBt  δ6 HMLt  δ7UMDt  δ8Timet  δ9Timet2  δ10ΔHOhmlt  δ11ΔIOhmlt  δ12ΔTOhmlt  εt
At the end of month t−1, we divide stocks into three groups based on the sign of analyst forecast revisions for panel A and into quintiles based on
standardized unexpected earnings for panel B using NYSE breakpoints. We further sort each group in both panels into quintiles based on the
aggregate information uncertainty measure using NYSE breakpoints. The top (bottom) quintile has the highest (lowest) information uncertainty.
For panel A, RHIU (RLIU) is the zero-cost hedge portfolio return of the highest (lowest) aggregate information uncertainty group long in positive
analyst forecast revision stocks and short in negative analyst forecast revision stocks. For panel B, RHIU (RLIU) is the zero-cost hedge portfolio
return of the highest (lowest) aggregate information uncertainty group long in firms with the highest standardized unexpected earnings and short in
firms with the lowest standardized unexpected earnings. Analyst forecast revision is the mean monthly analyst forecast revision for a firm, where
an individual forecast revision is the earnings forecast made by an analyst in month t−1 minus the previous earnings forecast made for the same
fiscal year-end by the same analyst scaled by the previous fiscal year-end stock price. Standardized unexpected earnings is the difference between
the most recent quarterly actual earnings as of month t−1 and analyst earnings forecast scaled by the share price 20 days before the earnings
announcement. The aggregate information uncertainty measure is calculated as the average ranking of seven individual information uncertainty
proxies defined in the appendix: accruals quality, firm size, firm age, analyst coverage, analyst forecast dispersion, cash flows volatility, and stock
return volatility. Post equals 1 for post-regulation (05/2003–12/2011) months and 0 for pre-regulation (01/1983–09/2000) months. We exclude the
transition period (10/2000−04/2003). The four factors are defined in Fama and French [1996] and Carhart [1997]. Time starts at 0.01 and increases
by 0.01 each month over the sample period. Time2 is the square of Time. ΔHOhml (ΔIOhml , ΔTOhml ) is the value-weighted average returns of
firms with the top 30 percent HO (IO, TO) change minus the value-weighted returns of firms with the bottom 30 percent HO (IO, TO) change. HO
(IO) is the number of shares held by hedge funds (institutional investors) divided by total shares outstanding. TO is share turnover defined as
shares traded divided by shares outstanding, demeaned by the relevant stock exchange average for NYSE/AMEX and NASDAQ over the sample
period to make it comparable across exchanges (Chen, Hong, and Stein [2002])). ***, **, and * indicate statistical significance at 1%, 5%, and 10%
based on t-statistics adjusted for heteroskedasticity, reported in parentheses.

52
 TABLE 5
Changes in Analyst Forecast Accuracy Conditional on the Aggregate Information Uncertainty Measure
Model 1 Model 2 Model 3
Intercept −0.80*** (−30.23) −1.52*** (−29.12) −1.51*** (−5.62)
Post 0.26*** (7.65) 0.07 (1.28) 0.18*** (2.72)
HIU −2.19*** (−30.60) −3.31*** (−23.59) −2.35*** (−5.27)
Post × HIU 1.04*** (10.47) 0.51*** (3.98) 1.64*** (6.54)
Time 1.05*** (14.73) 0.96*** (10.53)
Time × HIU 1.54*** (7.60) 2.75*** (9.41)
Time2 −0.27*** (−10.79) −0.19*** (−6.05)
Time2 × HIU −0.34*** (−4.71) −0.55*** (−7.40)
HO −0.02* (−1.77)
HO × HIU −0.00 (−0.10)
IO −0.00 (−0.27)
IO × HIU −0.05*** (−3.32)
TO −0.02*** (−3.05)
TO × HIU −0.01 (−0.71)
Adj. R2 70.37% 88.18% 89.50%

The table examines whether analyst forecast accuracy (FA) improved after the regulations, controlling for time trends,
institutional ownership, hedge fund ownership, and share turnover, using the regression:
FAp ,t  γ1  γ2 Post p ,t  γ3 HIU p ,t 1  γ4 Post p ,t  HIU p ,t 1  γ5Time p ,t  γ6Time p ,t  HIU p ,t 1  γ7Time 2p ,t 1  γ8Time 2p ,t  HIU p ,t 1
 γ9 HO p ,t  γ10 HO p ,t  HIU p ,t 1  γ11 IO p ,t  γ12 IO p ,t  HIU p ,t 1  γ13TO p ,t  γ14TO p ,t  HIU p ,t 1  ε p ,t
At the end of month t−1, we sort stocks into quintiles based on the aggregate information uncertainty measure, which is based
on the average ranking of seven individual information uncertainty proxies defined in the appendix: accruals quality, firm size,
firm age, analyst coverage, analyst forecast dispersion, cash flows volatility, and stock return volatility. FA is the portfolio mean
monthly forecast accuracy for each information uncertainty quintile. Forecast accuracy is the negative of the absolute difference
between the monthly earnings forecast and annual actual earnings scaled by share price at the end of the previous year. Post
equals 1 for post-regulation (05/2003–12/2011) months and 0 for pre-regulation (01/1983–09/2000) months. HIU is a dummy
variable equal to 1 for the highest information uncertainty quintile and 0 for the lowest information uncertainty quintile. Time
starts at 0.01 and increases by 0.01 each month over the sample period. Time2 is the square of Time. HO is the monthly portfolio
average hedge fund ownership (in percentage), defined as the number of shares held by hedge funds divided by total shares
outstanding. IO is the monthly portfolio average institutional ownership (in percentage), defined as the number of shares held
by institutional investors divided by total shares outstanding. TO is the portfolio average of monthly share turnover (shares
traded divided by shares outstanding), demeaned by the relevant stock exchange average for NYSE/AMEX and NASDAQ over
the whole sample period to make it comparable across exchanges (Chen, Hong, and Stein [2002])). The t-statistics in
parentheses are adjusted for heteroskedasticity. ***, **, and * indicate statistical significance at 1%, 5% and 10%.

53
 TABLE 6

The Short-term Impact of the Regulations on the Mispricing Effects

Analyst forecast revision effect (UR−DR) Post-earnings announcement drift effect (SUE5−SUE1)
Pre-regulation Post-regulation Post – Pre Pre-regulation Post-regulation Post − Pre
SFA1 (Lowest) 0.69*** (3.12) 0.39 (1.50) −0.30 (−0.87) 0.74** (2.47) 0.63** (2.13) −0.12 (−0.27)
SFA2 0.98*** (6.38) 0.02 (0.14) −0.96*** (−4.15) 0.90*** (3.10) 0.28 (1.20) −0.62 (−1.65)
SFA3 0.76*** (4.84) 0.11 (0.60) −0.65*** (−2.71) 0.56** (2.36) 0.20 (0.70) −0.36 (−0.97)
SFA4 0.91*** (4.18) 0.36* (1.83) −0.55* (−1.85) 1.08*** (3.66) −0.13 (−0.48) −1.21*** (−2.99)
SFA5 (Highest) 1.51*** (6.49) 0.27 (0.97) −1.24*** (−3.43) 1.35*** (4.91) 0.36 (1.36) −1.00*** (−2.62)
SFA5 − SFA1 0.82*** (2.69) −0.12 (−0.39) −0.94** (−2.15) 0.61 (1.56) −0.27 (−0.82) −0.88* (−1.73)

The table reports the intercepts from regressions of monthly portfolio excess returns on the Fama–French–Carhart four factor model:
Rt  Rft  α  βMKTt  sSMBt  hHMLt  uUMDt  εt
where R  Rf is portfolio excess return and the four factors are defined in Fama and French [1996] and Carhart [1997]. For individual regulations or pairs of contemporaneous
regulations, we calculate the mean monthly forecast accuracy in the last fiscal year before and the first fiscal year after the regulation was enacted, and the difference is the short-term
forecast accuracy change. We average the short-term forecast accuracy changes across regulations into a combined measure denoted SFA. We divide firms with available SFA into
quintiles, with SFA5 (SFA1) being firms with the highest (lowest) short-term forecast accuracy change around the regulations. We test whether the analyst forecast revision and
PEAD effects are conditional on SFA. For the analyst forecast revision effect, at the end of each month t−1, we divide stocks into three groups based on the sign of analyst forecast
revisions. UR − DR is a zero-investment portfolio long in upward analyst forecast revision stocks and short in downward analyst forecast revision stocks. For the PEAD effect, at the
end of each month t−1, we sort stocks into quintiles based on standardized unexpected earnings. SUE1 is the portfolio of lowest standardized unexpected earnings, SUE5 of highest
standardized unexpected earnings; SUE5 − SUE1 is a zero-investment portfolio long in firms with the highest standardized unexpected earnings and short in firms with the lowest
standardized unexpected earnings . Analyst forecast revision is the mean monthly analyst forecast revision for a firm, where an individual forecast revision is the earnings forecast
made by an analyst in month t−1 minus the previous earnings forecast made for the same fiscal year-end by the same analyst scaled by the previous fiscal year-end stock price.
Standardized unexpected earnings is the difference between the most recent quarterly actual earnings as of month t−1 and the analyst earnings forecast scaled by share price 20 days
before the earnings announcement. Forecast accuracy is the negative of the absolute difference between the monthly earnings forecast and annual actual earnings scaled by share price
at the end of the previous year. The pre- and post-regulation periods span January 1983 to September 2000 and May 2003 to December 2011. The t-statistics in parentheses are
adjusted for heteroskedasticity; ***, **, and * indicate statistical significance at 1%, 5%, and 10%.

54
 Table 7  

Controlling for the Impact of the Financial Crisis, Changes in Analyst Coverage and Delisting Status, and Changes in
the Values of Information Uncertainty Proxies 

Analyst forecast revision effect Post-earnings announcement drift effect

(UR − DR ): Post − Pre (SUE5 − SUE1): Post – Pre
Panel A: Excluding the financial crisis
IU1(Lowest) −0.97*** (−3.08) −0.16 (−0.45)
IU5(Highest) −1.85*** (−7.24) −1.77*** (−4.34)
IU5 − IU1 −0.88** (−2.24) −1.62*** (−3.23)
Panel B: Comparing later pre-regulation and earlier post-regulation period
IU1(Lowest) −1.00*** (−3.02) −0.11 (−0.28)
IU5(Highest) −2.07*** (−6.34) −1.52*** (−3.03)
IU5 − IU1 −1.07** (−2.44) −1.41** (−2.38)
Panel C: Analyst coverage and delisting
IU1(Lowest) −0.50* (−1.73) −0.48 (−1.60)
IU5(Highest) −1.29*** (−4.61) −1.94*** (−5.99)
IU5 − IU1 −0.78** (−2.41) −1.46*** (−3.73)
Panel D: Same information uncertainty quintiles pre- and post-regulation
IU1(Lowest) −0.63** (−2.10) −0.26 (−0.86)
IU5(Highest) −1.80*** (−4.10) −2.71*** (−5.23)
IU5 − IU1 −1.17** (−2.41) −2.45*** (−4.31)

The table reports difference-in-differences estimates for the analyst forecast revision and PEAD effects for several robustness tests.
Each difference-in-differences estimate is the change in risk-adjusted hedge portfolio returns from pre- to post-regulation between
high and low information uncertainty firms. Risk-adjusted returns are from regressions of monthly portfolio excess returns on the
Fama–French–Carhart four factor model:
Rt  Rft  α  βMKTt  sSMBt  hHMLt  uUMDt  εt
where R  Rf is portfolio excess return and the four factors are defined in Fama and French [1996] and Carhart [1997]. For the
analyst forecast revision effect, at the end of month t−1, we divide stocks into three groups based on the sign of analyst forecast
revisions. UR − DR is a hedge portfolio long in upward analyst forecast revision stocks and short in downward analyst forecast
revision stocks. For the PEAD effect, at the end of month t−1, we sort stocks into quintiles based on standardized unexpected
earnings. SUE1 is the portfolio of lowest standardized unexpected earnings, SUE5 of highest standardized unexpected earnings;
SUE5 − SUE1 is a hedge portfolio long in firms with the highest standardized unexpected earnings and short in firms with the lowest
standardized unexpected earnings. Panel A excludes the financial crisis from the post-regulation period, i.e., the pre- and post-
regulation periods span January 1983 to September 2000 and May 2003 to March 2007. Panel B compares the later pre-regulation
(January 1992 to September 2000) and early post-regulation (May 2003 to March 2007) sub-periods. Panel C limits the sample to
firms listed and followed by analysts both pre-regulation (January 1983 to September 2000) and post-regulation (May 2003 to
December 2011). For panels A–C, at the end of month t–1, we further divide each analyst forecast revision group and standardized
unexpected earnings group into quintiles based on the aggregate information uncertainty measure using NYSE breakpoints, with IU1
(IU5) being firms with the lowest (highest) aggregate information uncertainty measure. For panel D, we divide firms into quintiles
based on the aggregate information uncertainty measure one year before the regulatory transition period (October 1999 to September
2000), with IU1 (IU5) being the lowest (highest) aggregate information uncertainty quintile. Analyst forecast revision is the mean
monthly analyst forecast revision for a firm, where an individual forecast revision is the earnings forecast made by an analyst in
month t−1 minus the previous earnings forecast made for the same fiscal year-end by the same analyst scaled by the previous fiscal
year-end stock price. Standardized unexpected earnings is the difference between the most recent quarterly actual earnings as of
month t−1 and the analyst earnings forecast scaled by share price 20 days before the earnings announcement. The aggregate
information uncertainty measure is calculated as the average ranking of seven individual information uncertainty proxies defined in
the appendix: accruals quality, firm size, firm age, analyst coverage, analyst forecast dispersion, cash flows volatility, and stock
return volatility. The t-statistics in parentheses are adjusted for heteroskedasticity; ***, **, and * indicate statistical significance at
1%, 5%, and 10%.

55
 TABLE 8
Changes in the Analyst Forecast Revision Effect for U.S. and European Firms
Analyst forecast revision effect (UR−DR)
Pre-regulation Post-regulation Post − Pre
Panel A: U.S. listed firms
IU1 (Lowest) 0.34* (1.75) −0.09 (−0.45) −0.43 (−1.53)
IU2 0.64*** (2.95) 0.08 (0.44) −0.56** (−2.00)
IU3 1.05*** (3.72) 0.08 (0.41) −0.98*** (−2.88)
IU4 0.80*** (3.28) 0.42* (1.67) −0.38 (−1.09)
IU5 (Highest) 1.83*** (7.45) 0.22 (1.44) −1.61*** (−5.51)
IU5 − IU1 1.49*** (5.35) 0.32 (1.49) −1.17*** (−3.35)
Panel B: European listed firms
IU1 (Lowest) 0.55 (1.53) −0.01 (−0.09) −0.56 (−1.44)
IU2 0.50* (1.83) 0.26* (1.79) −0.24 (−0.77)
IU3 0.48 (1.60) 0.21 (1.29) −0.28 (−0.81)
IU4 1.05*** (3.03) 0.63*** (4.13) −0.41 (−1.09)
IU5 (Highest) 1.53*** (3.80) 1.26*** (6.77) −0.27 (−0.60)
IU5 − IU1 0.98** (2.17) 1.27*** (5.06) 0.30 (0.58)
Panel C: Difference between U.S. and European listed firms
IU1 (Lowest) −0.21 (−0.51) −0.08 (−0.30) 0.13 (0.27)
IU2 0.14 (0.40) −0.18 (−0.80) −0.32 (−0.77)
IU3 0.57 (1.37) −0.13 (−0.53) −0.70 (−1.45)
IU4 −0.25 (−0.59) −0.22 (−0.74) 0.03 (0.06)
IU5 (Highest) 0.31 (0.65) −1.04*** (−4.26) −1.34** (−2.53)
IU5 − IU1 0.51 (0.97) −0.96*** (−2.91) −1.47** (−2.36)

The table reports intercepts from regressions of monthly portfolio excess returns on the Fama–French–Carhart four factor model:
Rt  Rft  α  βMKTt  sSMBt  hHMLt  uUMDt  εt
where R  Rf is portfolio excess return and the four factors are defined in Fama and French [1996] and Carhart [1997]. Panel A reports changes in
the analyst forecast revision effect conditional on the aggregate information uncertainty measure based on the Fama–French–Carhart four factors for
U.S. firms and panel B for 16 European countries using European Fama–French–Carhart four factors (available from Ken French’s website). Panel
C reports differences between the two panels. At the end of each month t−1, we divide stocks into three groups based on the sign of analyst forecast
revisions. UR − DR is a zero-investment portfolio long in upward analyst forecast revision stocks and short in downward analyst forecast revision
stocks. Each analyst forecast revision group is divided into quintiles based on the aggregate information uncertainty measure, with IU5 the highest
information uncertainty group and IU1 the lowest information uncertainty group. Analyst forecast revision is the mean monthly analyst forecast
revision for a firm, where an individual forecast revision is the earnings forecast made by an analyst in month t−1 minus the previous earnings
forecast made for the same fiscal year-end by the same analyst scaled by the previous fiscal year-end stock price. The aggregate information
uncertainty measure is calculated as the average ranking of seven individual information uncertainty proxies defined in the appendix: accruals
quality, firm size, firm age, analyst coverage, analyst forecast dispersion, cash flows volatility, and stock return volatility. Portfolios are held for one
month and portfolio returns are equal weighted. The pre- and post-regulation periods span January 1991 to September 2000 and May 2003 to
December 2011. The t-statistics in parentheses are adjusted for heteroskedasticity; ***, **, and * indicate statistical significance at 1%, 5%, and 10%.

56
 TABLE 9

Regression Discontinuity Design for the Effect of SOX Section 404 on the PEAD Effect
Panel A: Summary statistics
N Mean Std. Dev. Q1 Median Q3
CAR 292 −1.35% −5.94% −17.65% 9.99% 28.01%
SUE 292 0.46% 0.32% −1.08% 1.52% 8.32%
MOM 292 2.27% −6.42% −29.35% 21.33% 47.46%
MR 292 0.58 1.00 0.00 1.00 0.50
PFL 292 73.48 72.55 61.39 86.63 14.41
PF752002 292 0.23 0.00 0.00 0.00 0.42
MV 292 125.66 107.34 74.95 149.82 80.07
BM 292 0.50 0.49 0.25 0.77 0.47
Panel B: Regression of cumulative abnormal returns after earnings announcement
Dependent Variable Cumulative abnormal returns after earnings announcement
Estimation Type OLS IV Approach
(1) (2) (1) (2)
SUER 0.27*** 0.27*** 0.24** 0.25**
(3.07) (2.89) (2.09) (2.15)
MR 0.18** 0.17** 0.16 0.16
(2.18) (2.08) (1.38) (1.27)
MR  SUER −0.38*** −0.38*** −0.41** −0.43**
(−3.02) (−2.83) (−2.02) (−1.98)
MV 0.01 0.01
(0.20) (0.33)
BM −0.00 0.00
(−0.18) (0.32)
MOM −0.00 −0.01
(−0.08) (−0.20)
Public float terms Yes Yes No No
Industry fixed effects Yes Yes Yes Yes
Observations 292 292 292 292
R2 8.18% 8.20% 6.18% 6.33%
First-stage regression, MR instrumented by PF752002, including first-stage controls, public float terms, and fixed effects
PF752002 0.41*** 0.39***
(8.60) (8.05)
First-stage R2 56.34% 53.63%

The table reports the results of the regression discontinuity design of Iliev [2010] to test the effect of SOX Section 404 on the PEAD effect. The test
concentrates on the first fiscal year ending on or after November 15, 2004 (referred to as year 2004 hereafter) and includes all firms with a public
float between $50 and $100 million. Panel A provides descriptive statistics for the variables in the test. Panel B reports results from the regression:
CARi  α0  a1SUERi  a2 MRi  a3MRi  SUERi  a4 MVi  a5 BM i  a6 MOM i  a7 PFLi  a8 PFL2i  a8 PFL3i  εi
where CAR is cumulative abnormal return, calculated as cumulative daily return adjusted by value-weighted market returns for the 60-trading days
following the earnings announcement. SUER is the ranked standardized unexpected earnings, measured as the difference between earnings of the
fourth fiscal quarter and the same quarter of the previous year scaled by the fourth fiscal quarter end share price, and ranked by  n  1  N  1 ,
where n is the standardized unexpected earnings rank and N is the total number of observations. MV is the log of market value (in millions) calculated
as share price times shares outstanding at the fiscal year end. BM is the total common equity over market value at the fiscal year end. MOM is the
compound past 11 months’ stock return ending one month before the earnings announcement. The regressions include a constant term (not reported
here). Public float terms include PFL, PFL2 , and PFL3 , where PFL is the public float in the second quarter of year 2004, and PFL2 and PFL3 are
the square and cube of PFL. Industry fixed effects are based on the Fama–French 12 sector definitions. For OLS regression, MR is a dummy variable
equal to one if the firm filed a management report in 2004. For IV approach, MR is the predicted treatment from the first-stage regression
instrumented by PF 752002 , which is a dummy variable equal to one for firms with public float greater than $75 million in 2002. The first-stage
regression has the same controls (MV, BM, and MOM), fixed effects, and public float terms as in the OLS regression. The t-statistics in parentheses
are adjusted for heteroskedasticity; ***, **, and * indicate statistical significance at 1%, 5%, and 10%.

57