Trust and Certification in Financial Markets: Evidence from Reactions to Earnings News

Abstract

We test whether trust affects how investors process financial information around earnings announcements. Using survey measures of social trust of local residents in the United States, we find that firms located in low trust regions experience significant under–reaction to earnings news. External certification – either by obtaining credit ratings or employing high quality auditors – helps to mitigate this effect. The passage of the Sarbanes-Oxley Act largely reduces the relation between trust and under-reaction to earnings surprises, highlighting the interconnection between trust, certification, and investor perceptions.