Why do Predicted Stock Issuers Earn Low Returns?

69 Pages Posted: 18 Nov 2016 Last revised: 9 Mar 2022

See all articles by Charles M.C. Lee

Charles M.C. Lee

Foster School of Business, University of Washington; Stanford University - Graduate School of Business

Ken Li

McMaster University - Michael G. DeGroote School of Business

Date Written: March 3, 2022

Abstract

Predicted stock issuers (PSIs) are firms with expected “high-investment and low-profit” (HILP) profiles that earn extremely low returns. We evaluate alternative explanations for this empirical phenomenon. Our results show top-PSI firms are cash-strapped, have lottery-like payoffs, high-volatility, high-beta, low-liquidity, and high shorting-costs. Over the next two years, top-PSIs earn return-on-assets of -30% per year, report disappointing earnings, and experience strongly negative forecast revisions. They perform poorly in down markets and are six times more likely to delist for performance-related reasons. Overall, we find substantial support for mispricing, some support for nonstandard-preferences, and virtually no support for the risk explanation.

Keywords: profitability, investment, market efficiency, mispricing, asset pricing models, stock issuance, external financing, investor sentiment

JEL Classification: G12, G14, G32, G40, G41

Suggested Citation

Lee, Charles M.C. and Li, Ken, Why do Predicted Stock Issuers Earn Low Returns? (March 3, 2022). Available at SSRN: https://ssrn.com/abstract=2870728 or http://dx.doi.org/10.2139/ssrn.2870728

Charles M.C. Lee (Contact Author)

Foster School of Business, University of Washington ( email )

224 Mackenzie Hall, Box 353200
Seattle, WA 98195-3200
United States

Stanford University - Graduate School of Business

Stanford Graduate School of Business
655 Knight Way
Stanford, CA 94305-5015
United States

Ken Li

McMaster University - Michael G. DeGroote School of Business ( email )

1280 Main Street West
Hamilton, Ontario L8S 4M4
Canada

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