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Firm valuation, abnormal earnings, and mutual funds flow

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Abstract

We examine the valuation effects of overall demand for corporate equities combined with the influence of abnormal earnings and unexpected funds flow. Our results indicate that the expected and unexpected net new total flow of funds into all stock mutual funds do not by themselves have a meaningful effect on firm equity valuation. However, we find the combination of unexpected funds flow and realized abnormal earnings have significant and important valuation effects. Importantly, the valuation impact is greatest for those firms with high earnings growth potential that also operate in an environment characterized by high information asymmetry.

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Notes

  1. For a more detailed explanation and discussion on information asymmetry see Dierkens (1991), Krishnaswami and Subramaniam (1999), and Krishnaswami et al. (1999).

  2. Consistent with the extant empirical literature we set the yearly expected rate of return on book value of common equity at 12% (Barth et al. 1999; Dechow et al. 1999; Hand and Landsman 2005). Also consistent with the existing literature, we utilize contemporaneous abnormal earnings in our analyses. We also ran the analyses with lagged abnormal earnings and obtained the same basic findings.

  3. Warther (1995) found that funds flow in the fourth month prior to the current period was non-significant.

  4. All regressions reported in tables were re-run while including a fixed effects variable for quarters. All of the fundamental results and inferences reported remained unchanged.

  5. For all OLS regressions documented in Tables 4–7, we report White (1980) adjusted t-statistics. We also ran all OLS analyses without the White’s adjustment to the standard errors. Although the t values were much larger in magnitude, the primary results and inferences for all variables remained the same.

  6. In order to get an approximation of the valuation impact, we estimated separate regressions for observations with the highest and lowest abnormal earnings to assess the impact of unexpected flow of funds on valuation. Based on coefficient estimates, an unexpected inflow of $100 million into the mutual funds increases the market valuation of the top one-third of the stocks with the highest abnormal earnings by an average value of $2 million. An unexpected outflow of $100 million from the mutual funds decreases the market valuation of the bottom one-third of stocks with the lowest abnormal earnings by an average value of $0.4 million. These are approximate estimates based upon broad aggregation of data in order to provide some indication of the valuation implications.

  7. The results of running the four basic regressions for this sub-sample (n = 175,383) are essentially the same as reported earlier for the full sample in Table 4.

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Acknowledgements

Raman Kumar acknowledges support from a Pamplin College of Business summer research grant. John Maher wishes to acknowledge support from the Jack Carroll research fellowship program in the Pamplin College of Business.

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Authors and Affiliations

  1. Department of Accounting and Information Systems, Pamplin College of Business, Virginia Tech, Blacksburg, VA, 24061, USA

    John J. Maher & Robert M. Brown

  2. Department of Finance, Pamplin College of Business, Virginia Tech, Blacksburg, VA, 24061, USA

    Raman Kumar

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  1. John J. Maher
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  2. Robert M. Brown
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  3. Raman Kumar
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Correspondence to John J. Maher.

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Maher, J.J., Brown, R.M. & Kumar, R. Firm valuation, abnormal earnings, and mutual funds flow. Rev Quant Finan Acc 31, 167–189 (2008). https://doi.org/10.1007/s11156-007-0065-4

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