Recent work suggests that institutional investors execute profitable trades based on private information about earnings and returns. We provide new evidence on the prevalence and sources of such informed trading by (1) testing for the creation and liquidation of positions based on private information, (2) introducing private information proxies that reflect the size and nature of an institution's position in each portfolio firm, and (3) using a methodology that examines multiple investor characteristics simultaneously at the institution-firm level. We find that changes in ownership by institutions with large positions in a firm are consistent with informed trading. However, other previously documented proxies for private information produce results more consistent with risk-based trading (e.g., investment style) or insignificant in the presence of other proxies (e.g., fiduciary type). We also find that informed trading is more prevalent in small firms and when the large positions are taken by investment advisers and large institutions. We appreciate helpful comments and suggestions from Cathy Schrand, Shyam Sunder, Ro Verrecchia, and workshop participants at the Carnegie-Mellon University Accounting Conference. We are grateful for the funding of this research by the Wharton School and the University of Arizona. Disciplines Accounting Which institutional investors trade based on private information about earnings and returns?Abstract Recent work presents evidence that certain groups of institutional investors are able to trade profitably based on private information about earnings and returns. We contribute to this literature in three ways. First, we test whether certain private information proxies are consistent with the creation and liquidation of positions based on private information. Second, we introduce private information proxies that reflect the size and nature of an institution's position in each portfolio firm. Third, we use a methodology that examines multiple investor characteristics simultaneously at the institution-firm-level. We find that changes in ownership by institutions that have large positions in a specific firm are consistent with trading based on private information. However, other previously-documented proxies for private information produce results that are more consistent with risk-based trading (e.g., investment style, portfolio turnover) or that are insignificant in the presence of the other proxies (e.g., fiduciary type). We also find that informed trading is more prevalent in return-based measures (vs. earnings-based measures) and in smaller firms. Tests for interactions among private information proxies reveal that informed trading is most evident when the large positions in firms are newly initiated and when they are taken by investment advisers and by large institutions. Finally, we find that institutions following growth strategies exhibit momentum trading in positions held less than one year and informed trading in positions held more than one year, suggesting that the ...

ABSTRACT:Corporate investment decisions require managers to forecast expected future cash flows from potential investments. Although these forecasts are a critical component of successful investing, they are not directly observable by external stakeholders. In this study, we investigate whether the quality of managers' externally reported earnings forecasts can be used to infer the quality of their corporate investment decisions. Relying on the intuition that managers draw on similar skills when generating external earnings forecasts and internal payoff forecasts for their investment decisions, we predict that managers with higher quality external earnings forecasts make better investment decisions. Consistent with our prediction, we find that forecasting quality is positively associated with the quality of both acquisition and capital expenditure decisions. Our evidence suggests that externally observed forecasting quality can be used to infer the quality of capital budgeting decisions within firms.

This study examines whether managers alter their financial reporting decisions in the face of investment-related pressure. We define investment-related pressure as the increased pressure managers feel to retain their job following an M&A poorly received by the market. We hypothesize that managers attempt to assuage pressure by delivering strong performance post-merger, creating incentives for misreporting. Our findings indicate that acquirers with more negative M&A announcement returns are more likely to misstate financial statements in the post-investment period and the issuance of misstated financials mitigates this pressure, at least in the near term. Our study contributes to the literature on the relation between corporate investing and financial reporting by showing how investment-related pressure leads to misreporting, even in a setting where the costs (e.g., greater probability of detection) are high. Our study also has implications for the large body of research that evaluates various consequences of M&As using post-merger performance. Specifically, researchers should be careful to distinguish real from misstated financial performance in the post-investment period. Data Availability: Data are available from the public sources indicated in the text.

Recent work suggests that institutional investors execute profitable trades based on private information about earnings and returns. We provide new evidence on the prevalence and sources of such informed trading by (1) testing for the creation and liquidation of positions based on private information, (2) introducing private information proxies that reflect the size and nature of an institution's position in each portfolio firm, and (3) using a methodology that examines multiple investor characteristics simultaneously at the institution-firm level. We find that changes in ownership by institutions with large positions in a firm are consistent with informed trading. However, other previously documented proxies for private information produce results more consistent with risk-based trading (e.g., investment style) or insignificant in the presence of other proxies (e.g., fiduciary type). We also find that informed trading is more prevalent in small firms and when the large positions are taken by investment advisers and large institutions. We appreciate helpful comments and suggestions from Cathy Schrand, Shyam Sunder, Ro Verrecchia, and workshop participants at the Carnegie-Mellon University Accounting Conference. We are grateful for the funding of this research by the Wharton School and the University of Arizona. Disciplines Accounting Which institutional investors trade based on private information about earnings and returns?Abstract Recent work presents evidence that certain groups of institutional investors are able to trade profitably based on private information about earnings and returns. We contribute to this literature in three ways. First, we test whether certain private information proxies are consistent with the creation and liquidation of positions based on private information. Second, we introduce private information proxies that reflect the size and nature of an institution's position in each portfolio firm. Third, we use a methodology that examines multiple investor characteristics simultaneously at the institution-firm-level. We find that changes in ownership by institutions that have large positions in a specific firm are consistent with trading based on private information. However, other previously-documented proxies for private information produce results that are more consistent with risk-based trading (e.g., investment style, portfolio turnover) or that are insignificant in the presence of the other proxies (e.g., fiduciary type). We also find that informed trading is more prevalent in return-based measures (vs. earnings-based measures) and in smaller firms. Tests for interactions among private information proxies reveal that informed trading is most evident when the large positions in firms are newly initiated and when they are taken by investment advisers and by large institutions. Finally, we find that institutions following growth strategies exhibit momentum trading in positions held less than one year and informed trading in positions held more than one year, suggesting that the ...

This paper provides evidence that financial reporting quality (FRQ) influences the holding costs of trading strategies. While prior research has focused on the benefits of investment strategies based on poor FRQ (i.e., larger returns due to a greater amount of private information), we examine whether poor FRQ imposes greater holding costs on certain trading strategies. We show that poor FRQ motivates sophisticated investors with short-term horizons to tilt their portfolios away from value stocks, whose returns are contingent on investors revising their beliefs about firm fundamental value, and toward past winner stocks, whose future returns are realized more quickly. Poor FRQ also increases the length of time that institutions maintain large positions in value stocks. Our results imply that mis-valuations can be persistent when arbitrageurs perceive high holding costs from poor financial quality, even when they can see through the opaque financial disclosures.