When Does Price Impound Information Unrelated to Earnings?

Abstract

Traditional measures of information content, using absolute returns and volume, document a surge in information content lasting several days after earnings announcements (EAs) and below average information content before EAs. These patterns contrast with theoretical predictions that price will immediately impound all publicly available information (Fama 1970) and that disclosure substitutes for private information production (Diamond 1985). We develop a measure of the information content of returns based on the earnings-return relation (ENR), and show that consistent with theoretical predictions ENR is elevated before, during and two days after EAs, but below average for an extended period beginning three days after EAs. ENR is significantly lower than a measure of information content based on absolute returns (ABR) between three and nine days after the EA suggesting a period of excess volatility after EAs. We validate the notion that ENR has incremental information about fundamental performance to ABR by demonstrating that during periods with high (low) ENR relative to ABR, there is increased (decreased) momentum, consistent with behavioral theories that momentum in returns arises because of under-reaction to information. We show ABR unrelated to ENR has a positive association with information acquisition and volume, consistent with a preference for transacting after EAs driving the volatility unrelated to earnings news in the post-announcement period.