Short sale constraints, heterogeneous interpretations, and asymmetric price reactions to earnings announcements

This study tests Miller’s (1977) overpricing hypothesis from a new angle. Specifically, we investigate the effects of heterogeneous interpretations on price reactions to earnings announcements. We find that the difference between good news and bad news earnings response coefficients increases with the degree of heterogeneous interpretations in the presence of short sale constraints. This pattern is more pronounced when short sale constraints are more binding. These findings support the notion that, under short sale constraints, stock prices selectively incorporate more optimistic opinions rather than the average opinion of all investors. Therefore, reducing short sale constraints should facilitate price discovery and improve price efficiency. This study complements recent studies examining the joint effect of short sale constraints and ex ante opinion divergence on price reactions to earnings announcements.