Limited Investor Attention and Stock Market Misreactions to Accounting Information

David Hirshleifer, Sonya Lim, and Siew Hong Teoh

Review of Asset Pricing Studies, December 2011


We provide a model in which a single psychological constraint, limited attention, explains both under- and overreaction to different earnings components. Investor neglect of earnings induces post-earnings announcement drift and the profit anomaly. Neglect of earnings components causes accrual and cash flow anomalies. The model offers empirical implications relating the strength of earnings-related anomalies to the forecasting power of current earnings-related information for future earnings, investor attentiveness, and the volatilities of and correlation between accruals and cash flows. We also show that, owing to attention costs, in equilibrium not all investors choose to attend to earnings or its components.

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