Market Reactions to Tangible and Intangible Information

Previous empirical studies suggest a negative relationship between prior 3-5 year fundamental performance and future returns: distressed firms outperform more profitable firms. In fact, we show here that after controlling for past stock returns firms with higher past fundamental returns actually outperform weaker firms. Our results are consistent with investors reacting appropriately to tangible information (defined as information which can be extracted from financial statements), but overreacting to intangible information. We explain these findings with a simple model based on the behavioral finding that investors are more overconfident about their ability to interpret intangible information. Finally, we reconcile our results with previous studies, and show that firms which grow through shareissuance activity experience low future returns, while firms that grow through increased profitability do not