Firm Complexity and PEAD
Alexander Barinov; Shawn Park; Çelim Yıldızhan
Terry College of BusinessUniversity of Georgia
June 12, 2014
Barinov, Park, Yıldızhan (UGA) Firm Complexity and PEAD June 12, 2014 1 / 23
Motivation
Firm Complexity
Cohen and Lou (JFE 2012) show that themarket has trouble digesting the informationabout multi-segment firms
They show that returns to a pseudo-conglomerate consisting of single-segment firmspredict returns to the real conglomerate
We are trying to understand what (other?) kindof information about multi-segment firms themarket has trouble digesting
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Motivation
Three Measures of Complexity
Conglomerate dummy (Conglo) - 1 if the firmhas multiple segments, 0 otherwise
Concentration (Complexity) - our main variable,equals to 1-HHI, HHI is based on segment sales
HHI=1 is a single-segment firm, HHI=0.5 - a firmwith two equal segments, HHI=0.1 is a firm withten equal segments
Number of segments (based on 2-digit SICcodes)
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Motivation
Complexity and PEADWe consider information in earningsannouncements: the market is known to be slowto incorporate it into prices (post-earningsannouncement drift, PEAD)The main hypothesis that complicated firmshave stronger PEAD, because it takes themarket longer to figure them outWe are fighting an uphill battle here, because allanomalies should be stronger for smaller,illiquid, more volatile firms, and complicatedfirms (conglomerates) are exactly opposite ofthat
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Firm Characteristics
Complexity andEarnings Announcements
Panel A1. Raw Values
Single Conglo All S-C A-CSUE 0.172 0.155 0.169 0.017 0.014t-stat 7.60 4.27 5.61 0.94 1.22EA 0.079 0.151 0.114 -0.072 -0.037t-stat 1.47 3.10 2.79 -1.82 -1.46
Panel A2. Absolute Values
Single Conglo All S-C A-CSUE 0.834 0.787 0.785 0.048 -0.002t-stat 16.9 18.5 18.5 1.76 -0.13EA 3.798 3.042 3.322 0.757 0.281t-stat 13.2 15.2 15.4 5.88 3.79
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Firm Characteristics
Complexity and Liquidity
Single Conglo All S-C A-CGibbs 0.695 0.449 0.612 0.246 0.162t-stat 10.1 20.3 11.1 4.48 4.08Spread 1.032 0.650 0.877 0.382 0.227t-stat 12.3 13.5 13.0 5.43 4.33Roll 1.824 1.342 1.650 0.481 0.308t-stat 14.7 20.2 16.5 5.19 4.43Amihud 0.040 0.020 0.028 0.020 0.008t-stat 4.55 3.46 4.55 5.98 10.22Zero 0.165 0.135 0.157 0.030 0.022t-stat 5.98 6.13 6.10 4.35 4.95
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Firm Characteristics
Complexity and Information
Single Conglo All S-C A-CSize 0.304 0.600 0.361 -0.296 -0.239t-stat 5.25 5.64 5.16 -5.54 -5.55IO 0.404 0.452 0.394 -0.048 -0.058t-stat 6.76 8.17 7.14 -6.97 -9.40# An 4.748 5.414 4.513 -0.667 -0.901t-stat 11.7 16.1 13.2 -5.28 -9.68IVol 2.033 1.598 1.854 0.435 0.255t-stat 14.6 21.2 17.5 4.73 4.20Turn 7.633 6.941 7.019 0.692 0.078t-stat 4.91 5.07 5.04 2.38 0.75
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Firm Characteristics
Characteristics: Summary
Conglomerates are more liquid thansingle-segment firms or Compustat firms
Conglomerates exist in a more transparentenvironment (more institutional ownership, moreanalysts, higher market cap, lower volatility)
Conglomerates witness smaller (in absolutemagnitude) surprises at earningsannouncements (and these surprises areprobably more positive)
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Complexity and PEAD
Fama-MacBeth Regressions
CAR+2;+60 = γ0 + γ1 · SUE0 + γ2 · Comp0 + γ3 · SUE0 · Comp0
γ1 > 0 - PEAD, γ3 > 0 - stronger PEAD for complicated firms
Defining PEAD as a coefficient in FM regressions meansmeasuring PEAD per unit of SUE
"Stronger PEAD for complicated firms" then does notnecessarily mean that the trading strategy based on PEADwill yield more if done for conglomerates only, becauseconglomerates have less extreme SUE
Rather, "stronger PEAD for complicated firms" means that ifone takes a conglomerate and a single-segment firm with thesame SUE, the conglomerate will have stronger PEAD
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Complexity and PEAD
PEAD and Conglomerates
1 2 3 4SUE 0.118 0.143 0.095 0.115t-stat 4.98 4.62 4.17 3.48Amihud -0.007 -0.007t-stat -1.81 -1.90SUE×Ami 0.320 0.323t-stat 3.56 3.37Conglo -0.001 -0.001t-stat -0.55 -0.27SUE×Cong 0.084 0.107t-stat 2.61 2.51
Barinov, Park, Yıldızhan (UGA) Firm Complexity and PEAD June 12, 2014 10 / 23
Complexity and PEAD
PEAD and Complexity
1 2 5 6SUE 0.118 0.143 0.099 0.123t-stat 4.98 4.62 4.36 4.00Amihud -0.007 -0.007t-stat -1.81 -1.91SUE×Ami 0.320 0.335t-stat 3.56 3.54Complexity -0.003 -0.002t-stat -0.64 -0.38SUE×Comp 0.184 0.218t-stat 2.73 2.70
Barinov, Park, Yıldızhan (UGA) Firm Complexity and PEAD June 12, 2014 11 / 23
Complexity and PEAD
PEAD and Complexity: Conclusions
The spread between 2.5th and 97.5th percentileof SUE is 0.27 - all slopes on SUE have to bedivided by roughly 4 to figure out PEAD
In the regression without control the slope is0.118 - that is, PEAD, on average, is roughly 3%(in the quarter after the announcement)
The slope on SUE × Conglo is 0.084 - PEAD isby roughly 2% stronger for conglomerates
Controlling for stronger PEAD for less liquidfirms increases the latter estimate by about 25%
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Complexity and PEAD
Complexity Matters
Full Sample 0<Comp<Med Comp>MedSUE 0.099 0.131 -0.074t-stat 5.26 3.04 -0.55Complexity -0.003 -0.012 0.002t-stat -0.64 -1.44 0.22SUE×Comp 0.184 0.448 0.458t-stat 2.73 2.03 1.71
1-HHI has a large mass at 0 - so, is it just conglomeratesversus standalones?
No, if we restrict the sample to conglomerates only, morecomplex conglomerates do have stronger PEAD
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New Conglomerates
New ConglomeratesConglomerates are different from standalones in manydifferent aspects
To make sure that it is the conglomerate status, andnot those differences that drive stronger PEAD forconglomerates, we look at PEAD in the two years afterthe new conglomerate is formed
We find that PEAD is stronger during the first twoyears of conglomerate’s life
Conglomerates still have stronger PEAD thanstandalones even as they get older
Interestingly enough, there is no stronger PEADpost-M&A - stronger PEAD for new conglomerates isdriven by "growth from within"
Barinov, Park, Yıldızhan (UGA) Firm Complexity and PEAD June 12, 2014 14 / 23
New Conglomerates
New Conglomerates
1 2 3SUE×Cong 0.100 0.100 0.100t-stat 2.91 2.91 2.91SUE×New 0.158t-stat 2.13SUE×M&A 0.046t-stat 0.39SUE×NoM&A 0.452t-stat 2.08
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Analyst Coverage
Specialists and Conglomerates
Information about conglomerates is hard toprocess, which should make analysts reluctantto cover them
In particular, we wonder whether specialists(covering five or more firms in the sameindustry) tend to abandon conglomerates
Specialists for conglomerates are defined basedon the largest segment, but defining them basedon all segments yields similar results
Barinov, Park, Yıldızhan (UGA) Firm Complexity and PEAD June 12, 2014 16 / 23
Analyst Coverage
No Size Matching
Panel B2. No Matching
Conglo Simple diff t-stat# Analysts 5.4 4.7 0.7 5.28# Specialists (SIC2) 4.3 4.0 0.3 2.41# Specialists (SIC3) 3.6 3.6 0.1 0.74% of Specialists (SIC2) 0.70 0.77 -0.07 -12.63% of Specialists (SIC3) 0.57 0.66 -0.09 -14.45Forecast Error 0.59 0.63 -0.04 -1.88
Despite conglomerates being larger, they are covered by thesame number of specialists as standalones
The fraction of specialists in their coverage is smaller
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Analyst Coverage
Size Matching
Panel B1. Size Matching
Conglo Simple diff t-stat# Analysts 5.4 6.6 -1.2 -7.53# Specialists (SIC2) 4.3 5.8 -1.5 -10.01# Specialists (SIC3) 3.6 5.2 -1.6 -11.06% of Specialists (SIC2) 0.70 0.81 -0.12 -12.42% of Specialists (SIC3) 0.57 0.71 -0.15 -14.46Forecast Error 0.59 0.50 0.09 3.29
Comparing conglomerates to standalones of the same size,their analyst coverage is much worse on all dimensions
Conglomerates are covered by less analysts, less specialists,smaller fraction of specialists
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Analyst Coverage
Analyst Coverage and PEAD
1 2 3SUE 0.066 0.091 0.083t-stat 3.03 4.36 3.86Complexity 0.000 0.002t-stat 0.03 0.30SUE×Comp 0.259 0.207t-stat 2.93 2.19# An 0.001 0.001t-stat 1.21 1.10SUE×# An -0.022 -0.021t-stat -4.71 -4.10
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Analyst Coverage
Specialist Coverage and PEAD
1 4 5SUE 0.066 0.091 0.084t-stat 3.03 4.39 3.94Complexity 0.000 0.003t-stat 0.03 0.53SUE×Comp 0.259 0.186t-stat 2.93 1.88# Spec2 0.001 0.001t-stat 1.50 1.40SUE×# Spec2 -0.020 -0.020t-stat -3.69 -3.39
Barinov, Park, Yıldızhan (UGA) Firm Complexity and PEAD June 12, 2014 20 / 23
Analyst Coverage
Analyst Coverage and PEADWe use residual coverage (residuals fromcross-sectional regressions of number ofanalysts/specialists on size) to control for sizeeffects
We find that firms with worse coverage (comparedto their peers of the same size) have strongerPEAD
Conglomerates have worse coverage too - is thatthe reason of stronger PEAD for conglomerates?
No, the relation between complexity and PEADweakens by only 25% after we control for therelation between PEAD and analyst coverage
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Other Results
Other ResultsThe relation between PEAD and complexity isconcentrated in the first 40 days after the announcementand dissipates afterwards (together with PEAD forstandalones that disappears after 40 days too)
Stronger PEAD for complex firms does not overlap withthe original Cohen and Lou effect (returns toconglomerates are predictable using returns topseudo-conglomerates)
Announcement returns are somewhat stronger forconglomerates too (their earnings are "moreinformative"), but the difference in the announcementeffects between conglomerates and standalones is notstrong enough to explain the difference in PEADs
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Conclusions
ConclusionsPEAD is stronger for complicated firms(conglomerates), despite conglomerates generallyhaving low limits to arbitrage
PEAD is stronger for more complicatedconglomerates
PEAD is stronger for new conglomerates,especially if they are not created through M&A
Conglomerates have worse analyst coverage, butcomplexity is broader than just the amount andquality of analyst coverage
Firm complexity is a new limits-to-arbitrage variableBarinov, Park, Yıldızhan (UGA) Firm Complexity and PEAD June 12, 2014 23 / 23