Finances can be confusing; even something as simple as saving money can give people trouble. When it comes to the stock market and investing, things can get even more unclear. Dr. Susan J. Crain, professor of finance at Missouri State University, spent a semester-long sabbatical researching the transparency of stocks, derivatives and financial statements to try and make things easier to understand for the public.
Understanding the problem
Many people have heard of the words “stock” and “derivative,” but they don’t understand how they work or how the market works around them. This can make things difficult for the public when investing and looking at annual financial reports from companies.
According to Crain, previous studies have shown that when those reports are released, there was a three-day window afterward that determined long-term reaction. For example, if reaction was negative during that three-day window, long-term reaction would be negative as well. This pattern showed that there was not a lot confidence in the information that companies were releasing.
However, with the passing of the Sarbanes-Oxley Act of 2002, companies were required to certify the accuracy of all information released. The intent was to eliminate fraud and make the entire process more transparent. What Crain and her co-authors wanted to do was test the three-day window pattern and see if it is still valid today.
“What I really focus on is market efficiency,” said Crain. “An efficient market is one in which the price of the security accurately reflects all available information about that security. We don’t have 100 percent efficient markets, so I like to look for potential mispricing of securities.”
Finding a pattern
Crain’s research team showed that the legislation was indeed effective.
“Our research is showing that those financial statements are being deemed more credible, and that people look at them and say, ‘Okay, I can believe in this information,’” said Crain. “So the pattern that we saw in the past doesn’t occur anymore.”
According to Crain, this change in pattern is in direct correlation with the passing of the Sarbanes-Oxley Act — proving the success of the legislation in making the market more efficient.
“In the past, volatility was really high after the annual report came out — probably because people were just trying to figure out ‘is this good news? Is this bad news? What’s not in there? How should we read between the lines?’” explained Crain. “Now, there’s just better information.”
For more information, contact Crain at (417) 836-6470.