Net Income Measurement, Investor Inattention, and Firm Decisions

59 Pages Posted: 18 Nov 2021 Last revised: 22 Jan 2022

See all articles by Natee Amornsiripanitch

Natee Amornsiripanitch

Federal Reserve Bank of Philadelphia

Zeqiong Huang

Yale School of Management

David Kwon

Yale School of Management

Jinjie Lin

Yale School of Management

Date Written: January 18, 2022

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, investment allocation decisions

JEL Classification: G11, G14, G22, G30, M41

Suggested Citation

Amornsiripanitch, Natee and Huang, Zeqiong and Kwon, David and Lin, Jinjie, Net Income Measurement, Investor Inattention, and Firm Decisions (January 18, 2022). Available at SSRN: https://ssrn.com/abstract=3963058 or http://dx.doi.org/10.2139/ssrn.3963058

Natee Amornsiripanitch

Federal Reserve Bank of Philadelphia ( email )

Philadelphia, PA
United States

Zeqiong Huang (Contact Author)

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

David Kwon

Yale School of Management ( email )

165 Whitney Ave
New Haven, CT 06511

Jinjie Lin

Yale School of Management ( email )

New Haven, CT 06520
United States

HOME PAGE: http://www.jinjie-lin.com/

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