Investor Overreaction in Microcap Earnings Announcements

Abstract

Response of investors to corporate earnings announcements have always been of special interest in behavioral finance in markets that are less liquid and less informed. This paper examines the overreaction case in microcap firms where analyst coverage is weakened and volumes traded are too insignificant and trade amidst hindrances of very high degrees of uncertainties presented by a microcap environment. This is done through the application of an event study methodology with a representative sample constituting microcap earnings announcements to explore abnormal returns in the short-run, and price adjustments. The findings suggest that investors tend to overshoot on the positive and negative sides when it comes to positive and negative earnings surprises respectively; this overreaction is partially rectified in the next few days. The above conclusions show the high probability of inefficiencies in microcap markets and the necessity of psychology to dictate the movements of the prices. The research is useful as it further develops the understanding of the working of behavioral biases in the absence of information dispersion. The implication to the investors is that the contrarian strategy may be used to take advantage of short-term mispricing among microcap firms whose policy and regulatory environment may need to be re-examined in order to provide enhanced transparency and reporting. The opportunities of the study defects are the problem of the availability of the information and opportunities to apply it to different markets, and the given obstacles could be avoided by future investigations.