Prospect Theory and the Timeliness of the Earnings Announcements: Empirical Evidence from Listed Chinese Firms

Abstract

Much empirical research on the timeliness of earnings announcements presents evidence for the good news early, bad news late rule. This paper goes further by dividing an individual firm's news content into two parts - unexpected earnings in relation to the previous year (news A) and unexpected earnings in relation to industry-wide medium earnings (news B) - and proves in theory that they play different roles in determining announcement dates given the assumptions that shareholders are reference dependent, loss averse, and have diminishing sensitivity, as the prospect theory describes, and that managers attempt to maximize the shareholders' valuation of the firm. Similar to previous studies, we find that news A is negatively correlated with reporting lag, but what distinguishes this research from previous work is that we find that it is news B that provides the underlying motivation for managers to move forward or delay the earnings announcement date, and that the probability of delaying an announcement increases as the difference between news B and news A increases. Finally, we find empirical evidence from listed Chinese firms to support our theoretical arguments.