Business Cycles, Firm Size and Market Reactions to News

Previous studies document that market reactions to firm-level earnings news are stronger during good times than in bad times. We find that this result is driven by small firms. In fact, the market reaction to large firms' earnings news is weaker during economic expansions than contractions. We then investigate five possible explanations. We find that the size effect on time-varying market reaction to news cannot be explained by the distinction between value and growth stocks, the entry and exit of new firms into the economy, earnings management, or time-varying earnings persistence. There is some evidence consistent with time-varying investor attention, but investor attention does not appear to completely explain our results. Our findings, therefore, remain a puzzle