Is the Mispricing of Bank Earnings Related to Financial Regulation Uncertainty?

We examine the impact of financial regulation policy uncertainty on mispricing of earnings among banks, which are heavily regulated and strongly influenced by such policies. The tension underlying our study stems from two opposing effects. To the extent that economic uncertainty generated by the regulatory process can trigger opinion divergence (rational attention) among investors, it is expected to delay (accelerate) the share price responses to banks' earnings announcements. Consistent with the dominance of opinion divergence effect, we show that regulatory uncertainty, measured through a news-based index, positively relates to post-earnings-announcement drift, forecast error and dispersion among analysts, and idiosyncratic return volatility. Our identification strategy also confirms that these effects are stronger among banks that are more sensitive to the regulations, i.e., banks with lower capital adequacy. Although financial regulations seek to provide capital market stability, our evidence implies that regulatory uncertainty can invoke negative externalities on market information efficiency