Are Foreign Firms at a Disadvantage in U.S. Capital Markets?

Written by UD Business Review | Oct 8, 2024 8:42:43 PM

Based on research by Jennifer Bannister, PhD, Li-Chin Jennifer Ho, PhD, and Xiaoxiao Song, PhD

Data analysis shows that, on average, companies that meet or beat analysts’ earnings forecast experience positive stock returns in U.S. capital markets. However, the market premium experienced for meeting or beating expectations is 35.58% lower for foreign firms than domestic firms. Strong legal enforcement and adoption of International Financial Reporting Standards in a company’s home country mitigates this disparity for foreign firms.

In addition to home country characteristics, investor familiarity with a firm’s home country impacts the significance of the market disparity. Results show that the discounted market premium experienced by foreign firms is only present when the native language and culture of the firm’s home country are deemed unfamiliar.

While foreign firms do not receive the same stock price rewards when meeting or beating analyst forecasts, they experience the same market penalty as domestic firms when they fail to meet these expectations.

Taken as a whole, the data suggest that U.S. investors exhibit a “home bias” toward foreign firms by discounting positive news for foreign firms compared to domestic firms and treating negative news similarly.

Key Points

Compared to domestic firms, foreign firms do not experience the same positive stock returns when earnings meet or beat analyst forecasts.
On the other hand, foreign firms suffer a similar market penalty as domestic firms when they fail to meet or beat forecasts.
Institutional characteristics of a foreign firm’s home country affect the level of disparity in market returns.
Language and cultural differences also impact the differing market returns.

Why This Matters

Investments in foreign firms are an important part of a well-diversified portfolio. However, investors must be aware of the risks associated with these investments. Depending on firm characteristics, it may be more difficult for investors to experience positive returns when dealing with foreign firms based on inherent market biases. Investors can mitigate these risks by investing in firms from countries with strong legal enforcement and that are less culturally distant from the U.S.

Managers of a foreign firm that is looking to raise capital in the U.S. should be aware of the challenges and the increased skepticism surrounding the earnings of foreign firms. While country-level factors cannot be influenced by an individual firm, managers can mitigate some investor concern and bias with increased transparency and communication.

Want to know more?

Numerous other factors can impact the market reaction to the news that a firm’s earnings meet or beat analyst expectations. For example, current market and economic conditions also impact the strength of the market reaction to positive or negative earnings surprises, as explained in a recent article from FactSet (linked below).