Institutional Consensus: Information or Crowding?

We test the information processing skills of institutional investors after earnings releases. If institutions can better process the implications of announced earnings, their trades should push prices to their fundamental values. In contrast, if institutions simply trade in the news direction without anchoring their demand to the fundamental value, their trading pressure should lead to price overreaction, consistent with the predictions of Stein (2009). Overall, we find that institutions push prices beyond their fundamentals when they trade in the direction of the earnings surprise. Importantly, contrarian trading by institutions positively affects price efficiency, especially when they are buying after bad news.