Earnings News Research Articles

Blinded by Lottery Preferences? Earnings News, Gambling-Motivated Trading, and Informational Efficiency

Blinded by Lottery Preferences? Earnings News, Gambling-Motivated Trading, and Informational Efficiency

The Salience Effect and Market Responses to Earnings News

The Salience Effect and Market Responses to Earnings News

Asymmetric response to earnings news across different sentiment states: The role of cognitive dissonance

Using the Chinese stock market data, we test the hypothesis that cognitive dissonance influences the stock market response to earnings news. Supporting this notion, we find that investors disregard earnings news that contradicts their sentiment due to cognitive dissonance, thereby causing a muted announcement date price reaction to such news. Further analysis shows that higher retail concentration and greater valuation uncertainty of the underlying firm exacerbate this cognitive dissonance and hence amplify its impact, but less credible financial report does not. Finally, we find that cognitive dissonance is temporary for bad news under optimism, but is quite persistent for good news under pessimism. Overall, our findings offer a behavioral bias explanation to understand why investors underuse accounting information.

DEVELOPING AN IMPROVED MEASURE OF EARNINGS MANAGEMENT

Over the last 30 years, researchers have developed different approaches to measure earnings management. This study builds on prior research and combines the total accrual approach and the earnings distribution after management approach to develop a more accurate measure of earnings management. Empirical results show that this refined measure developed in this study is able to more precisely identify firms that manipulated earnings (manipulators) and firms that did not manipulate earnings (non-manipulators). This contributes to the earnings management literature a more accurate measure of earnings management to meet or beat a specific earnings benchmark. The results of this paper has practical implications. In particular, practitioners (financial analysts and investors) can use the new measure developed in this study to more accurately detect firms' earnings management activities. This enables practitioners to better interpret firms' financial statements and earnings news.

Aggregate earnings and market expectations in United States presidential election prediction markets

This study uses election futures market data to provide the first empirical evidence that aggregate earnings conveys timely “election-relevant” information effecting betting market participants' expectations about the likely outcomes of United States presidential election campaigns. I document that aggregate earnings news is associated with multiple facets of U.S. economic health affecting voter utility. I then use high-frequency data from the Iowa Electronic Political Prediction Market (IEM) to document that aggregate earnings news, including cash flow news, is significantly related to changes in the expected outcomes of U.S. presidential elections and incremental of other measures of economic health.

The wisdom of crowds and the market's response to earnings news: Evidence using the geographic dispersion of investors

The wisdom of crowds suggests that groups with more diversely informed individuals reach more informed decisions because their members are collectively more knowledgeable. I study this idea in the context of the market's response to earnings announcements by examining how information diversity across investors affects the efficiency of the price response to earnings news. I measure investors' information diversity based on their geographic dispersion, which I estimate using the locations of the requests for firms' filings to EDGAR. Greater geographic dispersion is associated with greater trading during the announcement period; this supports the use of geographic dispersion as a measure of information diversity. Consistent with my predictions, the price response to a firm's earnings news is more efficient when the firm's investors have greater information diversity. In further analysis, I find that the initial heightened trading for firms with more diversely informed investors subsides quickly after the announcement period.

Accruals Quality, Shocks to Macro-uncertainty, and Investor Response to Earnings News

Research shows that a firm’s prior accrual quality affects the market reaction to earnings news, as it allows investors to gauge the level of noise in the news. Investor response to earnings news tends to be weaker (stronger) when a firm’s accrual quality is lower (higher). We aim to examine how macroeconomic shocks affect investor reactions. Drawing on ambiguity aversion literature, we argue that if macroeconomic uncertainty spikes before the earnings announcement, investors will favor a ‘better safe than sorry’ attitude; that is, they will tend to react strongly (weakly) to all bad (good) news, taking less into account differences in accrual quality. We consistently find that macro-uncertainty shocks cause (i) a stronger reaction to bad news for low-quality (but not high-quality) firms and (ii) a weaker reaction to good news for high-quality (but not low-quality) firms. The results are robust to alternative model specifications and sensitivity tests. Additionally, we show that if macro-uncertainty resolves in the post-announcement weeks, investors correct their underreaction to high-quality good news, especially if the shock is not extreme.

Trust in Financial Markets: Evidence from Reactions to Earnings News

This paper studies the effect of trust on the perceived credibility of earnings news. Using earnings response coefficients, we find that firms located in low-trust regions of the United States experience significantly lower stock price reactions to earnings news. Additional tests indicate that managers can counterbalance investors’ dependence on trust by employing reputable auditors or signaling the quality of their earnings using dividends to improve the perceived credibility of their financial reports. Overall, our findings suggest that trust affects the pricing of earnings news in capital markets. This paper was accepted by Brian Bushee, accounting. Funding: This work was supported by Ministry of Education (Singapore) [Grant RG161/14]. Supplemental Material: Data and the online appendix are available at https://doi.org/10.1287/mnsc.2022.4569 .

Worldwide earnings news and equity price movement: a supply-chain perspective

ABSTRACT This paper shows that worldwide earnings news can significantly influence the asset pricing in China, indicating the information transmission along the global supply chain. We investigate how stock prices of Chinese-listed firms react to the earnings announcements of their worldwide supply-chain partners and find that stock returns will exhibit a significant drift upwards (downwards) after the good (bad) news of their customers and suppliers. Moreover, we provide evidence that the equity price movement may be driven by the earnings information transmission between supply-chain partners and this effect is strengthened for the firms with higher information asymmetry or investor attention. Third, our primary results hold with a battery of robustness checks, including multiple controls consideration, proxy usage of earnings news, division of the sample, and length of market responses.

Market Reaction to Local Attention around Earnings Announcements in China: Evidence from Internet Search Activity

The existing literature shows that, due to locality and familiarity, spatial investor–firm adjacency plays a key role in determining stock investor attention, as proxied by the location where investors initiate an Internet search of the ticker symbol. This paper investigates whether Chinese stock markets exhibit the same pattern observed in the U.S. market—demand for a firm’s information can exert strong effects on the stock market response during earnings announcements of the firm. Specifically, for each Chinese publicly listed firm, this paper constructs a dynamic local attention ratio that divides the search volume generated within the province where the firm is registered by the contemporaneous nationwide search volume consisting of 31 provinces in total. During 2011–2018 in China’s A-share market, it was found that the local attention measure leads the market response around annual earnings announcement dates. For firms with higher local attention, trading is more active before the announcement, and the price changes can better predict incoming earnings news. At the announcement, while trading remains active, the predictivity of price changes for earnings becomes weaker. Furthermore, we only found evidence that supports the local information advantage argument in explaining the locality of Chinese investors’ attention.

Flight to Earnings: The Role of Earnings in Periods of Capital Scarcity

We examine the link between the scarcity of arbitrage capital and investors’ response to firms’ earnings information. The cost of financing levered investment strategies (i.e., investing with borrowed funds) increases in the risk profile of the securities being traded. As a result, when capital is scarce, levered traders face heightened incentives to tilt their portfolios in the direction of firms’ earnings information as an indicator of lesser risk because doing so mitigates financing constraints. Our results suggest that these investors become more responsive to firms’ earnings announcements when capital is scarce. Moreover, market prices display a stronger reaction to firms’ announcements and less postearnings announcement drift. Together, our findings suggest the scarcity of arbitrage capital spurs both the use of and responsiveness of market prices to firms’ earnings news. This paper was accepted by Brian Bushee, accounting. Supplemental Material: The online appendix and data are available at https://doi.org/10.1287/mnsc.2022.4538 .

Forecasting earnings with combination of analyst forecasts

We propose a regression-based method for combining analyst forecasts to improve forecasting efficiency. This method significantly reduces the bias in earnings forecasts, and generates forecasts that consistently outperform consensus forecasts over time and across firms of different characteristics. Incorporating firm-level and macroeconomic information in the model further improves earnings forecasting performance. Forecasting gains increase with the dispersion and bias of analyst forecasts, and the degree of under/overreactions to earnings news. Moreover, the combination forecast produces larger earnings response coefficients, weakens the anomaly of post-earnings-announcement drift, and provides a better expected profitability measure that has higher power to predict stock returns.

Less timely earnings announcements and voluntary disclosure

AbstractThe release of earnings information has become less timely in recent years partly because firms increasingly disclose earnings concurrently with their periodic reports (e.g., 10‐Ks, 10‐Qs). We examine whether firms use voluntary disclosure to mitigate the negative economic consequences of less timely earnings announcements (EAs). We find that firms with less timely EAs are more likely to provide voluntary 8‐K filings over the period leading to the EA. We also find that investors’ demand for timely information, the nature of earnings news and litigation risk affect the extent to which firms provide voluntary disclosure to compensate for less timely EAs. The negative effect of less timely EAs on information asymmetry is attenuated when firms provide voluntary 8‐K filings prior to EAs. Overall, our findings suggest that firms voluntarily communicate with investors using voluntary disclosure when their EAs are less timely.

Sentiment, Attention, and Earnings Pricing

We find that investor sentiment restrains the predictability of earnings news on announcement returns but the constraining effect of sentiment on the predictive power of earnings news diminishes as sentiment falls. We document that investor attention works as an important channel in the relation between investor sentiment and announcement returns. Investor attention enhances the immediate price reaction to earnings news by curbing the impact of sentiment on the predictive power of earnings news. Our findings reflect the joint effect of attention and sentiment on the source of excess returns documented in the prior earnings-based market anomaly literature.

Investors’ reaction under uncertainty

ABSTRACT This study investigates investors’ reaction to good/bad earnings news when faced with market- and industry-wide uncertainties. Our results provide little support for the discount rate explanation that investors’ reaction to good news is dampened during high market volatility. However, the results strongly support the learning hypothesis that earnings news provides value-relevant information for investors during periods of high-market volatility, but that investors cannot learn as much from earnings news under industry-wide uncertainty. These findings also support the conservation hypothesis that investors react more strongly to bad earnings news when faced with market-wide uncertainty.

Better to hear all parties: Understanding the impact of homophily in online financial discussion

• We investigate the impacts of homophily in online financial discussion on investor judgments, investment decisions, and market price efficiency. • Homophily reduces the accuracy of investor judgments on future stock returns and worsens investment decisions. • Homophily is associated with weaker immediate price reaction to earnings news and stronger post-earnings announcement drifts, implying reduced market price efficiency. As social media platforms have become popular venues for investors to share and exchange investment opinions to inform trading decisions, offline social phenomena such as homophily —defined as people’s inclination to seek interactions and associations with similar others—have also surfaced in online interactions. Yet relatively little is known about the economic consequences associated with investor homophily behavior in online social media. This study investigates how homophily in online financial discussion affects financial outcomes, particularly, investors’ judgments about assets’ future prospects and investment decisions, and overall market price efficiency. We theorize that, by reducing the diversity of information that investors access, homophily may lead to undesirable consequences for individual investors as well as the market as a whole. Analyzing approximately 33.5 million online postings by nearly 2.5 million investors from one of the largest social media platforms for investors in China, we find that, on average, homophily (1) reduces the accuracy of investor opinions about stocks’ future prospects, particularly, future stock returns, and (2) is associated with weaker immediate price reaction to earnings news and stronger post-earnings announcement drifts. Taken together, these findings reveal a dark side of homophily in online financial discussion, suggesting that falling prey to homophily could potentially lead to inferior investment decisions and welfare concerns, and aggregately, impair price efficiency and impede the efficient functioning of the capital market.

The Content of Tweets and the Usefulness of YouTube and Instagram in Corporate Communication

This study examines the content of corporate tweets related to earnings announcements and the incremental usefulness of YouTube and Instagram in disseminating earnings news. Textual analysis of tweets reveals that investors react more strongly to a firm’s communication on Twitter when it (i) includes financial information, (ii) mentions the CEO or the CFO, (iii) includes a visual element, and (iv) posts are written in a moderate tone. Tweets related to earnings announcements are particularly useful when retail ownership is high. Incrementally to Twitter, YouTube videos and Instagram posts do not have, on average, positive incremental effects on the price response to earnings news.

Disagreement between hedge funds and other institutional investors and the cross‐section of expected stock returns

AbstractWe find strong disagreements between hedge funds and other institutions in their common stock trades are twice as likely as agreements. Overall success of hedge funds’ trades and poor performance of non‐hedge funds’ trades are both confined to disagreement stocks. Although hedge funds are commonly positive feedback traders, they are neither positive nor negative feedback traders for stocks heavily sold by other institutions. Hedge funds also depend less on earnings news. Our findings highlight the importance of disagreement in studying the performance of institutional investors’ trades and are consistent with the notion that skilled investors rely less on public information.

Corporate governance, market conditions and investors’ reaction to information signals

We examine and compare the extent to which the reaction of investors to earnings announcements is influenced by a firm’s governance profile and prevailing market conditions. We find that firms with better governance characteristics experience a larger initial reaction to both good and bad earnings announcements regardless of the prevailing sentiment and uncertainty conditions. However, the influence of governance is constrained to the announcement period. We demonstrate that changes in market uncertainty and/or investor sentiment are related to the post-earnings announcement drift. We also find that a major channel through which greater corporate governance influences the market response to unexpected earnings news is by lowering information uncertainty and so providing greater clarity of the implication of the news for firm value. Finally, we establish that two types of uncertainties (market and information) have very different influence on investor’s response to information signals. JEL Classification: D81, G10, G14, G30, G32

Do Mutual Funds Trade on Earnings News? The Information Content of Large Active Trades

Using monthly holdings data, we show that in contrast to findings in existing literature, mutual fund trades in aggregate do not have predictive power for future earnings information. We identify active trades by mutual funds, that is, trades not passively driven by fund flows, and show that only large active trades by mutual funds contain information on future earnings. Moreover, we show evidence that large active trades by mutual funds help incorporate future earnings information into stock prices and significantly improve stock price efficiency. Finally, we show that large active trades by mutual funds prior to earnings announcements deliver superior abnormal returns. Mutual fund managers that actively trade on future earnings information are skilled; the top quintile skilled funds on average outperform those in the bottom quintile by 127 bps in four-factor alpha over subsequent four quarters.