The Signaling Role of Seemingly Myopic Investment Behavior

This paper exploits the 2003 mutual fund trading scandal to investigate firms’ seemingly myopic investment behavior following negative stock price shocks. Firms affected by the scandal are more likely to meet or marginally beat earnings targets by cutting research and development and other investment. This behavior is greeted with a more favorable market reaction and analyst forecast revision to earnings surprise and a speedier price reversal following the scandal. These findings are predictably stronger among firms with greater information asymmetry, suggesting that cutting investment to boost earnings can be a signaling tool for temporarily underpriced firms to convey financial health.