Net Income Measurement, Investor Inattention, and Firm Decisions

58 Pages Posted: 18 Nov 2021 Last revised: 3 Dec 2021

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: November 13, 2021

Abstract

ASU 2016-01 requires that public companies' net incomes recognize changes in unrealized gains and losses from investments in equity securities. This paper studies the rule’s effects on stock prices and firms’ capital allocation decisions. We build a model with risk-averse investors who can be attentive or inattentive and managers who maximize firms' stock prices. The model makes two main predictions. First, with inattentive investors, the rule change will cause stock prices to react more to changes in net income that stem from fluctuations in financial asset prices. Second, under certain conditions, inattentive investors will assign larger price discounts to firm values because of higher perceived residual uncertainty, and managers respond 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 unrealized gains and losses, 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

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 (November 13, 2021). 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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