“March Madness” distracts investors, disrupts market efficiency

(Foster School of Business, March 2016)

When the NCAA Division I Men’s Basketball Tournament tips off each spring, workplaces across America become enthralled by its panoply of Cinderella stories and buzzer-beaters, the riveting display of sheer athletic possibility playing out, at least initially, during normal business hours.

Not surprisingly, productivity suffers during “March Madness.”

The financial markets feel the distraction, too, according to new research by Jacob Thornock, an associate professor of accounting at the University of Washington Foster School of Business.

Thornock’s study of investor activity during more than a decade of NCAA tournaments demonstrates that the volume of trading drops markedly during the first round of March Madness, and the market response to earnings news is measurably muted.

“There’s no doubt that March Madness is a distraction to labor and productivity,” Thornock says. “But we didn’t expect to find the same distraction affecting financial analysts and investors—highly educated and motivated professionals who have considerable amounts of money on the line.”

Universal distraction

Every march, an NCAA selection committee invites 68 college men’s basketball teams from its Division I member schools to compete in the three-week, single-elimination tournament to decide the national champion.

This generates enormous interest and excitement. According to the NCAA, live broadcast of the 2015 tourney averaged 11.3 million viewers across four television channels. Another 17.8 million hours of action were consumed via live video stream on computers and mobile devices. March Madness inspired 350 million social media impressions.

And an estimated 40 million Americans filled out tournament brackets in competitions to see who can predict the results most accurately. WalletHub estimates that $12 billion is wagered on the tournament each year.

All of this adds up to a great deal of workplace distraction—especially during the tourney’s first round of 32 games that play out over a Thursday and Friday, with much of the action unfolding during the workday.

This distraction takes a toll. A study by Challenger, Gray & Christmas estimates that U.S. businesses will pay nearly $4 billion in wages to workers preoccupied by the opening rounds of this year’s tournament.

Count Thornock and co-author Michael Drake of BYU among the masses distracted by March Madness.

While working toward their doctorate degrees, Thornock and Drake would find themselves each March streaming games and obsessing over brackets, match-ups, predictions and upsets. “We noticed how distracted we were during March Madness,” Thornock says. “And we wondered if investors get distracted, too.”

Clean laboratory

They also realized that March Madness itself made a nearly perfect laboratory for the study of investor distraction. It is an annually recurring event that draws massive popular attention and plays out, at least in part, during trading hours.

And unlike other distracting events—such as a national election, terrorist attack or competing earnings announcements—the NCAA tourney has no implications on the financial markets. Florida Gulf Coast upsetting Georgetown or Weber State shocking North Carolina should have no bearing on securities pricing.

“March Madness provides a clean test of distraction that is not confounded by other political or economic factors that could also cause market reaction to be muted,” Thornock says.

Muted response

Using this clean test, Thornock, Drake and Kurt Gee of Stanford University compared market activity on the Thursdays and Fridays of NCAA tournament opening rounds (from 2000-2012) to Thursdays and Fridays outside of the tourney.

The most obvious evidence of distraction was in the volume of trading, which was significantly reduced for earnings released on March Madness days.

But the weekday diversion of college hoops also showed up in the form of abnormal investor response to earnings news. When firms disclosed earnings during the opening round of the tournament, market reaction was comparably muted.

So for instance, if a company’s earnings come in five percent over analyst projections, we’d expect to see the news send share prices immediately upward by an appropriate amount—under normal circumstances.

During March Madness, however, a critical mass of investors becomes distracted enough to make the overall market react more slowly to earnings announcements, with more “drift” in prices in the direction of the earnings signal.

“In other words,” Thornock says, “the reaction is incomplete. We expect the market to adjust quickly and completely to incorporate good or bad earnings news into price. Instead, we find that its response is slow and incomplete.”

The humanity of markets

Thornock emphasizes that this finding does not contain a get-rich-scheme for investors who remain attentive to earnings news while the masses obsess on college basketball games.

It also does not suggest a market dysfunction that should be cause for any real concern.

But it does reveal a systematic—though minor—flaw in market efficiency.

“There is a class of economist that believes markets are perfectly efficient, that they allocate resources quickly and efficiently, that there are too many rational economic agents with strong incentives to ever let distraction affect pricing,” Thornock says. “And it’s somewhat credible. I’m a believer in markets.

“On the other hand, a market is made up of humans. And in this paper we are able to cleanly capture that human element. It turns out that the market likes to watch a little basketball and gets distracted by March Madness just like everyone else.”

“March Market Madness: The Impact of Value-Irrelevant Events on the Market Pricing of Earnings News” is forthcoming in the journal Contemporary Accounting Research.