Small Negative Earnings Surprises and Transient Institutions’ Trading Behavior

We use a proprietary database of institutional investors’ daily stock transactions to test the validity of a common managerial perception that transient institutions sell their stock ownership indiscriminately upon announcements of small negative earnings surprises, resulting in unwarranted drops in stock prices. Consistent with the managerial perception, we find economically significant selling by transient institutions in response to small negative earnings surprises that is even larger than transient institutions’ selling in response to large negative earnings surprises. Transient institutions’ selling in response to small negative earnings surprises is also accompanied with significant contemporaneous stock price declines. However, transient institutions’ trading in response to small negative earnings surprises is positively associated with the abnormal returns subsequent to the earnings announcements, suggesting that their trading response is informative. Overall, our results refute the managerial perception.