Positive Earnings Surprises Research Articles

Individual investors and post-earnings-announcement drift: Evidence from Korea

This paper presents empirical evidence supporting the hypothesis that individual investors’ news-contrarian trading behavior drives post-earnings-announcement drift (PEAD). We find that after the announcement, individuals tend to trade in the opposite direction to earnings surprise, which impedes a full price response to earnings news, leading to under-reaction and PEAD. Moreover, we find that PEAD exists only for those stocks that individuals trade in the opposite direction to earnings news, and that the magnitudes of PEAD are greater for those stocks that are more intensely sold (for positive earnings surprise) and bought (for negative earnings surprise) by individuals.

(Presentation Slides) Do Individual Investors Cause Post-Earnings Announcement Drift? Direct Evidence From Personal Trades

This study tests whether naive trading by individual investors, or some class of individual investors, causes post-earnings announcement drift (PEAD). Inconsistent with the individual trading hypothesis, individual investor trading fails to subsume any of the power of extreme earnings surprises to predict future abnormal returns. Moreover, individuals are significant net buyers after both negative and positive extreme earnings surprises, consistent with an attention effect, but not with their trades causing PEAD. Finally, we find no indication that trading by individuals explains the concentration of drift at subsequent earnings announcement dates. The paper is available here: https://ssrn.com/abstract=1120495.

A Learning Curve of the Market: Chasing Alpha of Socially Responsible Firms

This paper explores stock market reactions to corporate social performance. We find that a value-weighted portfolio based on the list of “100 Best CSR companies in the world” published by Reputation Institute yields annual abnormal returns of 2.74% and 1.98%, by controlling for Carhart four factors and Fama French five factors, respectively. Moreover, such abnormal returns decrease as time goes, especially after the CSR lists were first published in 2013. The paper also indicates that companies with better social performance are more likely to have positive earnings surprises, and their returns are sensitive to earnings surprises. The results of this paper have three implications. First, CSR reputation can positively contribute to a firm’s short-term superior equity performance (i.e., factor-adjusted abnormal returns). Second, the CSR lists help the market correct mispricing of intangibles such as CSR reputation; the abnormal returns decrease as the market gradually learns about the value of firms’ social performance. Lastly, this paper contributes to the socially responsible investing (SRI) screens, a guide for investors who would like to do well by doing good.

Investor Horizons and the Reaction to Earnings Announcements

I study how investor horizons affect the price reaction of the stocks to earnings announcements. In the theory, short-run investors trade frequently, while long-run traders hold and trade on fundamentals. The model predicts that the reaction to an earnings announcement is shifted downward for stocks held short-term relative to those held long-term: a positive earnings surprise is less of a positive; a negative surprise is a larger negative. I test this prediction. I find that the reaction to earnings for ``short-term securities'' is dominated by the corresponding reaction for 'long-term securities.' The discrepancy persists over 75 days. These results are independent of security characteristics; they are robust to controls that capture various aspects of growth or value stocks.

Communication Strategy in Quarterly Earnings Calls: The Importance of Tone and Agenda Setting Theory

This study aims to provide insight into communications strategy through the lens of agenda setting theory. Prior research finds that “positive tone” on an a company’s quarterly earnings call (QEC) can offset a negative earnings surprise; however, the concepts of “Positive” and “Negative” are seldom unpacked and thus difficult to operationalize from a practitioner’s point of view. Utilizing content analysis this paper disaggregates tone into 40 different verbal elements and measures the effectiveness (in terms of short term simple and abnormal returns of company market value) of the usage of these elements in situations when companies either met or underperformed their earnings targets. Additionally, these verbal elements are analyzed for both the prepared remarks and Q&A portions of verbal communication events between company management, analysts and investors. The empirical findings in this study show that communication strategy for the QEC event appears to not differ materially across either positive or negative earnings surprise contexts in either the prepared or spontaneous remarks. Thus, management does not appear to be using the call as a strategic communications opportunity. The results suggest that management is not actively employing agenda setting theory in the calls and as a result may be negatively impacting company value.

Board Structure Mandates: Consequences for Director Location and Financial Reporting

We examine how the director independence and financial expertise mandates of the Sarbanes-Oxley Act (SOX) impacted board geography and financial reporting quality. Using 1998-2007 data on the residential addresses of individual directors, we document that directors on audit and other monitoring committees became significantly more distant from headquarters after SOX. The increase in distance was driven by firms that faced tight supply constraints in local director labor markets. We also find that firms experiencing an increase in the distance of financial experts around SOX exhibit a drop in earnings quality as well as a weaker (stronger) stock-market response to positive (negative) earnings surprises. Our findings suggest that, for some firms, the independence and financial expertise mandates led to changes in board geography that had negative consequences for financial reporting.

Analyst information precision and small earnings surprises

This study proposes and tests an alternative to the extant earnings management explanation for zero and small positive earnings surprises (i.e., analyst forecast errors). We argue that analysts’ ability to strategically induce slight pessimism in earnings forecasts varies with the precision of their information. Accordingly, we predict that the probability that a firm reports a small positive instead of a small negative earnings surprise is negatively related to earnings forecast uncertainty, and we present evidence consistent with this prediction. Our findings have important implications for the earnings management interpretation of the asymmetry around zero in the frequency distribution of earnings surprises. We demonstrate how empirically controlling for earnings forecast uncertainty can materially change inferences in studies that employ the incidence of zero and small positive earnings surprises to categorize firms as suspected of managing earnings.

The Integrity of Financial Analysts: Evidence from Asymmetric Responses to Earnings Surprises

This paper investigates the integrity of financial analysts by examining their recommendation responses to large quarterly earnings surprises. Although there is no significant difference in recommendation changes between affiliated and unaffiliated analysts in response to positive earnings surprises, affiliated analysts are more reluctant than unaffiliated analysts to downgrade stock recommendations in response to negative earnings surprises. The evidence implies that conflicts of interest undermine the integrity of financial analysts. We further examine the effects of reputation concern and the Global Research Analyst Settlement as informal and formal mechanisms, on restoring analysts’ integrity. The results show that the positive bias in recommendations remains prevalent for affiliated analysts from reputable investment banks and for the postreform period. Finally, evidence from market reactions suggests that investors fail to notice that analysts’ integrity is compromised by conflicts of interest and are misled by affiliated analysts.

Insider Trading and Post-Earnings Announcement Drift

This paper examines the association between insider trading during the pre-earnings announcement period and the magnitude of the post-earnings announcement drift (PEAD). Consistent with insiders’ private information being incorporated into prices through their trading, we find PEAD is significantly lower when earnings announcements are preceded by insider trading. This negative association between insider trading and PEAD is stronger when information asymmetry between insiders and outsiders is higher, and when internal and external monitoring of insider trades is weaker. However, in contrast to our primary results, we find that in cases of confirming insider trading (i.e., high levels of insider buying (selling) preceding large positive (negative) earnings surprises), PEAD is significantly larger. Our evidence suggests such trades are based on insiders’ private information about earnings surprises in subsequent quarters and the market fails to fully account for the information contained in these trades. Overall, our findings indicate insider trading contributes to stock pricing efficiency by conveying insiders’ private information to the market.

Insider Trading and PEAD

This paper examines the association between insider trading during the pre-earnings announcement period and the magnitude of the post-earnings announcement drift (PEAD). Consistent with insiders’ private information being incorporated into prices through their trading, we find PEAD is significantly lower when earnings announcements are preceded by insider trading. This negative association between insider trading and PEAD is stronger when information asymmetry between insiders and outsiders is higher, and when internal and external monitoring of insider trades is weaker. However, in contrast to our primary results, we find that in cases of confirming insider trading (i.e., high levels of insider buying (selling) preceding large positive (negative) earnings surprises), PEAD is significantly larger. Our evidence suggests such trades are based on insiders’ private information about earnings surprises in subsequent quarters and the market fails to fully account for the information contained in these trades. Overall, our findings indicate insider trading contributes to stock pricing efficiency by conveying insiders’ private information to the market.

Short-Term Investors, Long-Term Investments, and Firm Value

This paper shows that an inflow of short-term institutional investors pressures firms to cut R&D investment to report higher earnings and to generate positive earnings surprises, and also leads to temporary boosts in firm valuations. When these short-term investors subsequently leave, the reductions in R&D, higher earnings, and the increase in firm valuations are reversed. Our identification strategy exploits plausibly exogenous variation in the presence of short-term investors around Russell 2000 index inclusions, which are associated with a sharp temporary inflow of short-term institutions and a permanent increase in institutional ownership and analyst coverage.

Predictors of the Degree of Positive Earnings Surprises

This study identifies the predictors of positive earnings surprises at varying levels of earnings surprises under strong and weak business conditions (2014 and 2010, respectively). It measures the impact on surprises of a unique and diverse set of predictors such as analyst coverage and industry type which are security characteristics and sales and cash flow that emanate from financial statements. The study employs technology stocks that were found on the NASDAQ as such stocks have reported high positive earnings surprises from 2013-2015 [1]. The entire population of positive earnings surprises for 8316 NASDAQ stocks in 2010 and 2014 was used. Event studies were used to measure abnormal return and abnormal volume at earnings announcement, while multiple regressions tested the influence of the predictors of positive earnings surprises including number of analysts, sales, cash flow and industry type. Number of analysts significantly predicted positive earnings surprises of 100% regardless of business condition, while sales and industry type showed similar results for weak business conditions. Cash flow explained positive earnings surprises in the 21% - 30% earnings surprises range for weak business conditions, while industry type was significant in the 100% earnings surprises categories for strong business conditions.

Is a Small Positive Sales Surprise a Red Flag for Manipulation?

Prior research suggests that investors see a small positive earnings surprise as a warning sign indicating an increased chance of creative accounting. This study finds that investors see a small positive sales surprise as another warning sign of manipulation. I compare the coefficient in the regression of abnormal stock returns on sales surprise (while controlling for earnings surprise) across ranges of sales surprises using all firm-quarters with sufficient data in the period 2005-2013 as my sample. The coefficient is lower for small positive sales surprises than for surprises in any other range. I also find that investor skepticism toward small positive sales surprises is rational. Small positive sales surprises are more likely to reverse in the future than sales surprises in any other range. Moreover, analysts react to small positive sales surprises in a way that suggests they also expect these sales surprises to reverse in the future.

Attracting Attention in a Limited Attention World: Exploring the Causes and Consequences of Extreme Positive Earnings Surprises

We investigate why extreme positive earnings surprises occur and the consequences of these events. We posit that managers know before analysts when extremely good earnings news is developing, but can have incentives to allow the earnings news to surprise the market at the earnings announcement. In particular, managers can use an extreme positive earnings surprise to attract investor attention when they believe their stock is neglected and future performance is expected to be strong. Analysts, who must allocate scarce resources across many firms, can also be inattentive and miss signals that suggest good performance is going to be announced. Using various proxies for extreme positive earnings surprises, management expectations for future performance and desire for attention, and analyst neglect, we find evidence that an extreme positive earnings surprise is a predictable event. These findings are incremental to controlling for a firm’s information environment, earnings volatility, and operating leverage. Finally, we show that extreme positive earnings surprises are a successful method for attracting attention, with significant increases in the number of institutional owners, the number of analysts, and trading volume during the subsequent three years. This paper was accepted by Mary Barth, accounting.

Merger Means of Payment and Analyst's Forecast Bias Before Merger Announcement Date

We find strong evidence that analysts tend to have downward-biased earnings estimates immediately before merger announcement dates when earning announcement date is within a 60 day window prior to merger announcement date. Compared to pure stock deals, acquirer stocks in cash-only deals tend to experience a more pronounced positive earnings surprise on the earning announcement date in the above time frame. An event study within three days window of earning announcement date that is within 60 days prior to M&A announcement date allows us to capture market price reaction toward means of payment impact on near term analysts’ forecast bias. We find 0.72% (0.43%) cumulative abnormal return for the acquirer stocks of cash only (Pure stock) deals during this specific time frame. Our findings complement the analyst’s conflict of interest hypothesis, suggesting analyst’s earnings forecast right before merger announcements may be influenced by merger means of payment.

Do sophisticated investors interpret earnings conference call tone differently than investors at large? Evidence from short sales

Recent research finds that investors, broadly defined, react to the linguistic tone of quarterly earnings conference calls; there is a positive relation between firms' stock returns and call tone (a measure of “sentiment” related word tabulations). However, this type of soft information can be subtle, context-specific, and difficult to interpret. Moreover, the literature suggests cross-sectional variation in information processing skills among investors. Thus, we test whether sophisticated investors interpret earnings conference call tone differently than investors at large by examining short selling activity and its relation to earnings conference call tone. We find that short sellers target firms with simultaneous high earnings surprise and abnormally high management tone. The combination of positive earnings surprise and unusually positive tone strengthens short sellers' return predictability. This result indicates that short sellers interpret revealed “inflated” call language by managers more completely than naïve investors. The incomplete stock price reaction by naïve investors due to the lack of reliability that they place on this soft information results in overpricing of the stock. However, it also suggests that managers are unable to maintain prolonged overvaluation of their stock by striking an overly optimistic posture in the interactive conference call disclosure forum since short sellers' trades provide additional price discovery.

The Valuation Premium for a String of Positive Earnings Surprises: The Role of Earnings Manipulation

Prior research finds that firms that consistently report positive earnings surprises earn a valuation premium (a higher price-to-earnings ratio). However, the role of earnings management is not definitive because of the high correlation between positive earnings surprises, economic growth, and accruals. We first provide unambiguous evidence linking manipulation to the consistent reporting of positive earnings surprises. Specifically, we show that an unusually high proportion of firms subject to SEC enforcement actions for earnings manipulation report consecutive positive earnings surprises. We next examine whether manipulating managers are motivated by the fear of losing an existing valuation premium or out of greed to obtain a valuation premium. Consistent with fear being the primary motivation, we document that manipulating firms already have high market expectations and are valued at a premium before manipulation starts. This premium is maintained during the manipulation period but is completely lost after the manipulation is discovered. Additional analyses suggest that (i) achieving an earnings string through manipulation is short-lived, lasting only one or two years; and (ii) manipulating managers do not use earnings guidance as a secondary tool to walk down analysts’ forecasts.

Market reaction on income smoothing in the Indonesian manufacturing industry

The capital market reactions are proxied by cumulative abnormal return (CAR) and stock trading volume (STV) activity, while for the earnings information the proxy of unexpected earnings was used. This research used independent samples tests. The result shows that when measured by CAR, the market does not show any different reaction, but when measured by STV, the market reactions of the income smoothing group are significantly different from those of the non-income smoothing group. Then the sample were split into two group of positive earnings surprise and negative earnings surprise. The positive earnings surprise group shows no different market reaction when measured by CAR, but show different market reaction when measured by STV. The negative earnings surprise group shows no different market reaction when measured by CAR and STV.

Insiders Time Well Both Their Purchases and Sales: They Trade after Large Earnings Announcement Abnormal Returns

This paper conjectures that insiders exploit their stock's mispricing after earnings announcements to make profitable trades. We design two sets of tests to provide evidence of insider trading on mispricing of their stock. First, insiders' purchases and sales are profitable both after positive and negative earnings surprises, which indicates that their trading strategies are superior to simple contrarian or momentum trading strategies. Second, we estimate a model of 'normal' market reaction to an earnings announcement and use the deviation of the fitted value from the realized market reaction as our measure of mispricing after earnings announcements. In line with the mispricing hypothesis, we show that insiders sell (buy) more often after large positive (negative) values of our mispricing measure and earn significant post trading returns.

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