Are Sin Stocks Paying the Price for Accounting Sins?

Abstract

Recent empirical evidence suggests that sin stocks—publicly traded stocks in the gaming, tobacco, alcohol, and adult entertainment industries—are neglected by stock market participants because of social norms, regulatory scrutiny, and litigation risk. Consequently, these firms experience low institutional ownership, low analyst following, and higher expected returns. This paper examines whether higher information risk in the form of poor financial reporting quality offers an explanation for the higher expected returns of sin firms. Inconsistent with this explanation, we find that the financial reporting quality of sin firms is superior relative to a variety of control groups along two dimensions: predictability of earnings for future cash flows and timely loss recognition. These results imply that, despite superior returns and higher financial reporting quality, investors are willing to neglect sin stocks and instead bear a financial cost in order to comply with societal norms and reflect non-financial tastes in their portfolio.

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