This paper measures the degree to which disclosed annual financial information assimilates into stock prices through financial production process (FPP) efficiency. This study aims to analyse if FPP efficiency is a proxy for behavioural bias in the price discovery process and whether it is determined by the proximity of the current price to price anchors. The FPP efficiencies of 611 listed Indian firms across 11 industries for nine years are computed using data envelopment analysis (DEA). Results show that a significant number of sample stocks are FPP inefficient. Long-short portfolios of inefficient and efficient firms generate positive returns, implying that FPP efficiency is mean-reverting. As the inefficiencies correct over time, the FPP-inefficient stocks enjoy higher returns than the FPP-efficient stocks. A Tobit regression analysis indicates that proximity to chosen price anchors (historically high and low prices) determines the FPP efficiencies.
Thus, the research establishes FPP efficiency as a determinant of stock returns. It contributes to the literature by providing a possible explanation for the mispricing due to behavioural bias in the FPP by arguing that FPP efficiency is a proxy measure of behavioural bias in stock prices. It argues that investor attention to price anchors (historical highs and lows) might affect the assimilation of published financial information into prices.
The literature in the field of FPP efficiency and its determinants is sparse. Moreover, this is the first study in the Indian context that uses a considerably large panel data sample. The proposed method demarcates the Indian stocks that are FPP inefficient and fail to reflect the available disclosed information in their stock prices quickly. The findings and their implications may be useful for investors and portfolio managers. They can adopt a similar methodology to identify relatively undervalued stocks and take appropriate positions.
