Measuring the effect of investor sentiment on financial distress

Abstract

Purpose

This study examines the effect of firm-level investor sentiment on a firm's level of financial distress.

Design/methodology/approach

The authors use Bloomberg's firm-level, daily investor sentiment scores derived from firm-level news and Twitter content in a beta-regression model to explain the variability in a firm's financial distress.

Findings

The results indicate that improvements (deterioration) in investor sentiment derived from both news articles and Twitter content lead to a decrease (increase) in the average firm's financial distress level. We also find that the effect of sentiment derived from Twitter on a firm's financial distress is significantly stronger than the sentiment derived from news articles.

Research limitations/implications

Our proxy for financial distress is Bloomberg's financial distress measures, which may be an imperfect measure of financial distress. Our results have important implications for market participants in assessing the determinants of financial distress.

Practical implications

Our sample period covers four years (2015–2019), which is determined by Bloomberg sentiment data availability.

Social implications

Market participants are increasingly using social media to express views on firms and seek information that might be used to determine a firm's level of financial distress. Our study links investor sentiment derived from social media (Twitter) and traditional news articles to financial distress.

Originality/value

By examining the relationship between a firm's sentiment and its financial distress, this paper advances our understanding of the factors that drive a firm's financial distress. To our knowledge, this is the first study to link US firms' investor sentiment derived from firm-level news and Twitter content to a firm's financial distress.

Citation

Dunham, L.M. and Garcia, J. (2021), "Measuring the effect of investor sentiment on financial distress", Managerial Finance, Vol. 47 No. 12, pp. 1834-1852. https://doi.org/10.1108/MF-02-2021-0056