How Does a Firm’s Rumor Response Practice Affect Investors’ Reactions to Rumors?

Abstract

Despite the unverified nature of rumors, prior research suggests that investors’ judgments and financial market outcomes often reflect an overreaction to rumors. I use an experiment to examine how a firm’s rumor response practice affects investors’ reactions to rumors (i.e., their expected change in stock price and willingness to invest). Drawing on psychology theory on mental simulation, I predict and find that when rumors have positive (negative) implications, investors expect a greater increase (decrease) in stock price when the firm has a rumor response practice that is a no-comment practice compared to a discretionary practice. While I do not find a direct effect of rumor response practice on willingness to invest, I find that a firm’s rumor response practice impacts investors’ willingness to invest through their expected change in stock price. I also provide supplemental evidence of the effects of rumor response practice on ease of simulation. This study contributes to the growing literature on the effects of management disclosure practices and information intermediaries on investors’ judgments. My results also inform managers and other stakeholders about how a firm’s rumor response practice can have an unintended consequence of amplifying investors’ reactions to rumors.