Industry Leaders, Limited Attention, and Spurious Cross-Industry Information Diffusion

What is it about?

Within an industry, stock returns of larger firms lead those of smaller firms, suggesting an intraindustry information diffusion process. Most industry leaders, however, have business segments in other industries (henceforth, minor-segment industries), whereas most small firms are pure players operating in one industry only. If investors cannot filter out the irrelevant information from the leaders' minor segments, the pure players will be mispriced due to spurious cross-industry information diffusion (SCIID). Consistent with the SCIID hypothesis, we document both a strong contemporaneous and a lead–lag relation in stock returns between firms from industry leaders' minor-segment industries and pure players in the industry leaders' major-segment industry. Our results are not due to potential missing common factors or economic relationships between pure players and firms in the minor-segment industries.

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Photo by Markus Spiske on Unsplash

Photo by Markus Spiske on Unsplash

Why is it important?

Small firms' returns are not only affected by information related to its own industry, but also by information spuriously diffused from other industries though the industry leaders. The spurious information from other industries leads to mis-pricing, which in turns may be exploited by arbitrageurs. The spurious information diffusion is also a reason why smaller firms are more often mispriced than large firms. The reliability of price signal for small firms is compromised by the spurious informaiton diffusion.

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