Academic journal article The International Journal of Business and Finance Research

Do Neglected Firms Suffer from an Information Deficit?

Academic journal article The International Journal of Business and Finance Research

Do Neglected Firms Suffer from an Information Deficit?

Article excerpt

ABSTRACT

We study the presence and distribution of private information in neglected firm stocks using a measure of private information first suggested by Roll (1988). Our results suggest that there is no shortage of information on neglected firms for investors and that this private information forms part of the decision set for managerial decisions. Our results indicate a significant negative correlation between the amount of private information and certain important firm characteristics such as market size, cashflow, sales and return on assets. When the impact of private information is analyzed on the investment and payout policies of the neglected firms, the results indicate that private information in stock price has a significant impact on firm investment but not on payout. However, private information does affect payout but through interaction with firm cash flow. Finally we find that private information impact on firm investment is stronger in smaller as compared to larger neglected firms.

JEL: G14; G35

KEYWORDS: Neglected stocks, Neglected firms, information deficit

INTRODUCTION

Market efficiency requires availability of costless information. Much of this information is generated by financial analysts for use by the investing public. When stocks, because of the small size of the issuing firm or other factors, do not attract the attention of financial analysts, they are likely to be priced to provide a significant information risk premium to any potential investor. However, investors trade not only on the basis of public information but also on the basis of their private information. We study the presence and distribution of private information based on firm characteristics and find a strong negative correlation between private information and several firm characteristics. We then study the effect of private information on the investment and payout policies of the neglected firms. Our results show that private information in price is positively correlated with the level of firm investment, while private information in cash flow is positively correlated with the level of payout. We surmise that this is private information of investors because of the way in which we construct the sample of neglected firms i.e. firms with no analyst coverage and low institutional ownership. This ensures that managers of the neglected firms cannot send information through analysts or institutional investors. In addition, low insider ownership among the sampled firms suggests that neglected firms' response to private information is less likely to be distorted by managerial incentives. We find that private information affect the investment of smaller firms more than that of larger firms. But barring this exception, we do not find size, sales or profitability to systematically influence either the investment or payout levels of the neglected firms.

The rest of the paper is organized as follows: Section II reviews the relevant literature, while Section III provides the data and methodology. Section IV reviews the results while Section V concludes.

LITERATURE REVIEW

Neglected firms, defined as firms with little or no analyst, media or institutional coverage, are enigmatic. Some researchers such as Arbel et al (1983) and Arbel and Strebel (1983) show that neglected stocks earn a premium either as compensation for associated information deficiencies and/or pricing inefficiencies caused by lack of information. These researchers find the information deficiency premium to average 10.7% for the 5-year period 1972-76. The neglected firm effect persists whether neglect is measured in terms of analyst coverage or actual investment by institutions and even after size and risk are controlled. However, if the market for information is efficient, then the information deficit should be fully discounted in the price and the observed neglected firm effect may actually be caused by other factors, such as missing variables or value-affecting attributes of securities not captured by CAPM or market model. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.