Trading Volume Reactions to Earnings Announcements and Future Firm Performance

Abstract

This study examines the relation between abnormal trading volume (ATV) around earnings announcements (EAs) and future stock returns. In particular, I investigate whether firms with higher ATV around EAs outperform those with lower ATV over the short and long terms following the EA. In addition, I address whether any positive relation between ATV around EAs and future stock returns is weaker for firms with a higher proportion of shares held by sophisticated investors. Consistent with theories that attribute ATV around public announcements primarily to differing investor interpretations of the news and that link differential interpretation to future returns, I find that, for several quarters after an EA, firms in the highest decile of ATV significantly outperform those in the lowest decile. Further, I find that ATV and earnings surprises explain future returns incremental to the three Fama and French (1993) and momentum risk-factors. Next, consistent with the proportion of ATV driven by lack of consensus regarding the price being lower when the presence of rational investors is higher, I document that the level of investor sophistication − a proxy for investor rationality − attenuates the positive relation between ATV and future returns. Taken together, my study lends support to and links two streams of theories from financial economics, and demonstrates that trading volume reactions to EAs provide information about future returns that cannot be deduced from the price reactions or the magnitudes of earnings surprises. My study also documents that while the positive relation between ATV and future returns is prolonged and persistent, it is sensitive to the level of security holdings of sophisticated investors.