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30 January 2020 CFA Institute Journal Review

Attention for the Inattentive: Positive Effects of Negative Financial Shocks (Summary)

  1. Mark K. Bhasin, CFA

This is a summary of "Attention for the Inattentive: Positive Effects of Negative Financial Shocks," by Paige Ouimet and Geoffrey Tate, published in the Review of Finance.

Negative shocks lead to more-optimal portfolio choices among previously inattentive investors. Employees in employee stock purchase plans (ESPPs) do not actively select into ownership, and many remain passive within these plans. They are more likely to exercise options, sell restricted stock, and participate in their ESPPs after a negative financial shock, and their more active participation can improve their returns.

What Is the Investment Issue?

The 2008–09 financial crisis nudged passive investors in employer-sponsored ownership plans (ESPPs) to overcome the cognitive costs of becoming informed and active decision makers within their plan. Employee stock compensation plans are offered to help attract, retain, and provide incentives for high-quality employees. The benefits of such plans are limited, however, if employees make suboptimal participation and trading decisions. Because these plans allow employees to purchase stock at a discount, improving employee participation increases employee wealth. Decisions to not participate reduce both the plans’ value and employee satisfaction.

How Did the Authors Conduct This Research?

The authors use aggregated, non-identifiable data provided by an equity compensation administration service provider; the information provided includes data on grants of employee stock options and restricted shares as well as participation in ESPPs for 500 publicly traded firms between 2004 and 2013. The authors align employee equity ownership data with company accounting data from Compustat and stock price data from CRSP. They assess changes in employees’ active decision making by identifying changes in their option exercise patterns, ESPP participation, and restricted stock sales around the 2008–09 financial crisis. To calculate these changes, the authors create two time windows: a 36-month pre-crisis period from 2005 to 2007 and a symmetric 36-month post-crisis period from 2010 to 2012. The analysis excludes the years 2008 and 2009.

After measuring changes in the aggregate, the authors use variation in the cross-section to investigate competing economic explanations for the aggregate effects. Several regressions are used to measure, among other factors, changes in employee option exercise patterns and employee behavior within their firms’ ESPPs. Investor experience is a critical independent variable, which is measured based on the number of years that the employee has received stock options grants before January 2005, the beginning of the pre-crisis period. The frequency with which the employee has received option grants in the past is used as a proxy for investment experience because each grant involves the employee making the decision to hold or exercise the options based on volatility, asset prices, and the diversification of the employee’s investment portfolio.

What Are the Findings and Implications for Investors and Investment Professionals?

The authors demonstrate that educational intervention can affect employees differently based on their past experiences as well as the point in time. Investors are most amenable to improving their understanding of employee stock compensation plans after negative market returns. Investors managed their plans more actively in the three-year period after the 2008–09 financial crisis, as evidenced by an increase from a 40% participation rate pre-crisis to a 55% participation rate post-crisis, which indicates a greater willingness to overcome the costly cognitive hurdles that limit their understanding of the plans. The increase in participation came primarily from those with less experience with employee options and purchase plans, bringing newer and less educated investors into the plans.

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