How Investor Sentiment Influences Stock Price Informativeness of Firms’ Future Earnings: Evidence From China’s Stock Market

This paper explores whether the level of stock price informativeness about listed companies’ future earnings is influenced by investor sentiment. In prior studies, investor sentiment, which can be regarded as the mood of the market, is defined as a belief about unjustified firms’ future cash flow, investment returns and risks in capital markets. At the same time, stock price informativeness indicates how much information about a firm’s future earnings is reflected by stock prices. Higher price informativeness indicates a higher market efficiency level. Using linear regression analysis based on panel data from China’s stock market and listed companies, this research documents how stock price informativeness can be reduced by investor sentiment during market pessimism. However, although the explanatory power of future earnings over stock returns is strengthened by positive sentiment, it is not certain that positive sentiment increases price informativeness since the asset price bubble exists with extreme market optimism. Furthermore, the effect of sentiment on price informativeness would be weakened by higher state-owned shareholding. These empirical results imply that sentiment, to a certain degree, causes the investors’ ignorance during pessimism and exaggeration during optimism over firms’ earning prospects. Moreover, investors usually lack favour for state-owned enterprises during optimism, even though these companies actually have considerable earning prospects. While during pessimism, which usually happens after a crisis, the profitability and reliability of these state-owned enterprises are again emphasised by investors.