How Does Experts' Limited Attention Affect Stock Prices?

The “market efficiency” models of finance cannot fully explain stock prices. A robust violation of market efficiency is stock prices’ underreaction to earnings news. One argument for such violation is that information experts such as (sell-side) analysts, whose revealed knowledge structure (such as earnings forecasts) investors significantly rely on to evaluate stocks, fail to process earnings news. To understand such experts’ failure and consequent market inefficiency, we take a new institutionalism approach and examine the context-bound attention of the analysts.  Specifically, we examine the attention-limiting role of competing tasks and distracting events in influencing analysts’ earnings forecasts for firms. Using a sample of 5,136 North American public firms and 10,798 analysts over 2000-2012, we find that competing tasks worsen analysts’ earnings forecast accuracy. Also, stock prices’ underreaction to earnings news is significantly positively associated with the number of analysts’ competing tasks. Hence, stock price is better understood by an approach that integrates sociological new institutionalism, cognition, and efficient market models. Also, we illustrate how micro-attentional constraints of a few individuals (experts) can sum up to a robust macro-evidence of market inefficiency or erroneous macro-cognition.