Net Income Measurement, Investor Inattention, and Firm Decisions
Dr. Zeqiong Huang
Assistant Professor of Accounting
Yale School of Management
This paper studies the impact of net income measurement on stock prices and firm’s resource allocation decisions when investors have limited attention. We build a model in which investors use accounting information to value the firm and the manager chooses the size of investment portfolio in financial assets to maximize the firm’s stock price. We compare two accounting regimes, one including investment gains and losses and one excluding it. We characterize the conditions under which investors assign larger price discounts under the inclusive regime, and under which managers respond to such discounts by cutting investment portfolio. We also test these predictions using the implementation of Accounting Standards Update (ASU) 2016-01, which requires public firms to incorporate changes in unrealized gains and losses (UGL) on equity securities into net income. Using insurance company data, we find that stock prices react more strongly to equity UGLs after the implementation, and the impact is more pronounced for firms with low analyst coverage. Furthermore, compared to private peers, publicly traded insurance companies significantly cut investments in equity securities. Taken together, these results highlight the effects of investor inattention.
