Product Market Competition and Overreaction to Intra-Industry Information Transfers

This study investigates the effect of product market competition on overreaction to intra-industry information transfers. Prior studies show that the stock market overreacts to information transfers resulting from the earnings announcements of early peer firms; however, few studies show how overreaction to information transfers occurs. This study reveals that investors overreact more to information transfers in higher product market competition. It also finds that in competitive environments, investors overreact to negative transfers more than they do to positive transfers. The results imply that investors do not fully understand the differential persistence between industry-wide and firm-specific news released by the industry, which is consistent with the functional fixation hypothesis. Additional analyses also reveal that overreaction to information transfers is less observed when firms are less competitive: the announcement firms are bellwether firms or firms in industries with high sales growth. The results are robust when an alternative measure of product market competition is used. This study has academic and practical implications, showing that product market competition can lead to stock market mispricing in the context of information transfers.