This study investigates the effect of product market competition on overreaction
to intra-industry information transfers. Prior studies show that the stock market
overreacts to information transfers resulting from the earnings announcements of
early peer firms; however, few studies show how overreaction to information
transfers occurs. This study reveals that investors overreact more to information
transfers in higher product market competition. It also finds that in competitive
environments, investors overreact to negative transfers more than they do to
positive transfers. The results imply that investors do not fully understand the
differential persistence between industry-wide and firm-specific news released by
the industry, which is consistent with the functional fixation hypothesis.
Additional analyses also reveal that overreaction to information transfers is less
observed when firms are less competitive: the announcement firms are bellwether
firms or firms in industries with high sales growth. The results are robust when
an alternative measure of product market competition is used. This study has
academic and practical implications, showing that product market competition
can lead to stock market mispricing in the context of information transfers.