Orange is the New Black: Changing Landscapes of Earnings Surprises and the Market Reaction

Abstract

In this paper, we examine the changing time-series properties of the earnings-return relation and explore the implications of its changing landscape for the literature. We document strikingly opposite time-series patterns of earnings surprises and associated market reaction. Earnings surprises have been increasing over time, with the mean analyst forecast error rising from negative 8 cents in 1990 to positive 1.4 cents in 2019. However, average earnings announcement returns have declined from 0.30% in 1990 to -0.35% in 2019, turning negative in the past 15 years. As firms strive to meet or beat earnings expectations, strong past performance of a firm and strong performance of other firms raise the market’s earnings expectation above analysts’ consensus forecast, leading to investors’ disappointment upon earnings announcements. Our evidence has broad implications for appropriate earnings benchmarking, for empirical design when examining the earnings-return relation, for a disappearing earnings announcement premium, and for disappearing discontinuity in the earnings surprise distribution around zero.