Limited Attention to Detail in Financial Markets: Evidence from Reduced-Form and Structural Estimation

AuthorZ. Sautner, H. Cronqvist, T. Ladika, E. Pazaj
JournalJournal of Financial Economics
Date2 April 2024
CategoryAcademic Publications
Volume154
Page numbers103811

We show that firm valuations fell after a key expense became more visible in financial statements. FAS 123-R required firms to deduct option compensation costs from earnings, instead of disclosing them in footnotes. Firms that granted high option pay experienced earnings reductions, while fundamentals remained unchanged. These firms were more likely to miss earnings forecasts, and they experienced recommendation downgrades and valuation declines. Our findings suggest that market participants exhibited limited attention to option costs before FAS 123-R. As we reuse the FAS 123-R natural experiment, we show how one can address confounding channels by integrating reduced-form and structural estimation.