Net Income Measurement, Investor Inattention, and Firm Decisions

Natee Amornsiripanitch, Zeqiong Huang (), David Kwon () and Jinjie Lin ()
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Zeqiong Huang: https://som.yale.edu/faculty/zeqiong-huang

No 22-05, Working Papers from Federal Reserve Bank of Philadelphia

Abstract: When investors have limited attention, does the way in which net income is measured matter for firm value and firms’ resource allocation decisions? This paper uses the Accounting Standards Update (ASU) 2016-01, which requires public firms to incorporate changes in unrealized gains and losses (UGL) on equity securities into net income, to answer this question. We build a model with risk-averse investors who can be attentive or inattentive and managers who choose how much to invest in financial assets to maximize firms’ stock prices. The model predicts that, with inattentive investors, stock prices react more to changes in UGL from equity securities under the new regime and, under certain conditions, investors assign larger price discounts. Managers respond to such discounts by cutting financial asset holdings. We use insurance company data to test these predictions. Prices of stocks with low analyst coverage react more to changes in UGL from equity securities, highlighting the role of investor inattention. Using a difference-in-differences approach, we find that by 2020, publicly traded insurance companies cut investments in public stocks by $23 billion.

Keywords: Net income components; investor inattention; ASU 2016-01; capital allocation decisions (search for similar items in EconPapers)
JEL-codes: G11 G14 G22 G30 M4 M41 (search for similar items in EconPapers)
Pages: 59
Date: 2022-02-14
New Economics Papers: this item is included in nep-acc
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DOI: 10.21799/frbp.wp.2022.05

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