Quarterly Earnings Announcements Research Articles

The Market's Reaction to Unexpected Earnings Thresholds

Abstract: We examine differences in quarterly earnings announcement returns as a function of meeting or missing each of three earnings thresholds – reporting a profit, reporting an increase in earnings, and meeting analysts’ forecasts. In contrast to prior research, the research design identifies the incremental market reaction to the profit and earnings increase thresholds, after controlling for the effect of meeting or missing analysts’ forecasts. Using this methodology, we find little evidence of incremental threshold effects beyond meeting analyst forecasts. In other words, zero earnings and a zero change in earnings do not appear to be ‘special’ points that elicit a differential response by investors. Our results are robust to including a number of control variables and alternative tests. The fact that we find little evidence to support market‐related incentives to manage earnings at the profit and earnings increase thresholds suggests either that managers have other incentives to manage earnings at these thresholds or that managers perceive market rewards and penalties when none exist.

Consequences of auditor reputation loss for client firms: deterioration of financial reporting quality after the Andersen collapse

This paper examines how Andersen’s role in the Enron collapse may have influenced the perceived financial reporting quality of its audit clients. We examine investor response to quarterly earnings announcements by Andersen clients and a sample of matched companies audited by other Big Five auditors. We find that investor response to fourth quarter 2001 earnings announcements for Andersen clients worsened compared to the prior year. In addition, this response to 2001 earnings was more negative for Andersen clients than for clients of other Big Five auditors after the Enron scandal was revealed. Such findings suggest that the loss of auditor reputation was not only a generally stigmatising event for clients, but also specifically undermined confidence in the clients’ financial reporting integrity.

Measuring The Usefulness Of Information For Investors Inferences: The Case Of Quarterly Earnings Announcements

In this paper, we propose a new method for assessing the usefulness of information, its inferential value. In the context of accounting and finance, we define the inferential value of information about a firm as how efficaciously the information enables investors to draw correct inferences regarding its future financial performance. On the basis of this definition, we develop a stylized model to measure the proximity of a firm’s future realized rates of return to the estimated rates of return implied by its current stock price. We then use the new measure to test the hypothesis that quarterly earnings announcements have a higher inferential value than other information arriving during interim (non-earnings announcement) periods. Our empirical findings suggest that investors are able to make more informative inferences about a firm’s future profitability based on quarterly earnings announcement than based on information available during interim periods. However, our findings also suggest that, in general, investors do not correctly anticipate future losses. Finally, we find that earnings announcements are as important in anticipating future profitability for larger firms as they are for smaller firms.

How Important are Earnings Announcements as an Information Source?

In a competitive information market, a single information source can only dominate other sources individually, not collectively. We explore whether earnings announcements constitute such a dominant source using Ball and Shivakumar's (2008) [How much new information is there in earnings?, Journal of Accounting Research, 2008, 46(5), pp. 975–1016] R 2 metric: the proportion of the variation in annual returns explained by the four quarterly earnings announcement returns. We find that the earnings announcement days' R 2 is 11% – higher than the corresponding R 2 of days with dividend announcements, management forecasts, preannouncements, and 10-K and 10-Q filings and their amendments, and comparable to that of the four days with the largest realised absolute returns in a year. Additional analysis reveals that earnings announcements convey extreme bad news as often as management forecasts and preannouncements; for any other type of news, earnings announcements are much more frequent. We conclude that earnings announcements are an important source of new information in the equity market.

Earnings Conference Call Content and Stock Price: The Case of REITs

Using computer based content analysis, we quantify the linguistic tone of quarterly earnings conference calls for publicly traded Real Estate Investment Trusts (REITs). After controlling for the earnings announcement, we examine the relation between conference call tone and the contemporaneous stock price reaction. We find that the tone of the conference call dialogue has significant explanatory power for the abnormal returns at and immediately following quarterly earnings announcements. The question and answer portion of the conference calls dominates prepared managerial introductory remarks in explanatory significance. Furthermore, an overall positive tone in the conference call discussion between management and analysts is found to nearly offset the damaging effects of a negative earnings surprise.

How Important are Earnings Announcements as an Information Source?

In a competitive information market, a single information source can only dominate other sources individually, not collectively. We explore whether earnings announcements constitute such a dominant source using Ball and Shivakumar’s (2008) R2 metric: the proportion of the variation in annual returns explained by the four quarterly earnings announcement returns. We find that the earnings announcement days’ R2 is 11 percent — higher than the corresponding R2 of days with dividend announcements, management forecasts, preannouncements, 10-K and 10-Q filings, and their amendments, and comparable to that of the four days with largest realized absolute return in a year. Additional analysis reveals that earnings announcements convey extreme bad news as often as management forecasts and preannouncements; for any other type of news earnings announcements are much more frequent. We conclude that earnings announcements are an important source of new information in the equity market.

Information Externalities Along the Supply Chain: The Economic Determinants of Suppliers’ Stock Price Reaction to Their Customers’ Earnings Announcements

We study the economic determinants of the information externality suppliers experience at the time of their customers’ quarterly earnings announcements (QEAs). We measure the information externality as suppliers’ stock price reaction to their customers’ QEAs. We expect information externalities to arise because the information revealed in customers’ QEAs can revise investors’ expectations about the level of suppliers’ future earnings and cash flows, and or because it resolves uncertainty about those future earnings and cash flows. We find that the information externality experienced by suppliers is increasing in the: (1) magnitude of the new information disclosed at customers’ QEAs; (2) strength of the economic bond between the firms, (3) components of the earnings information disclosed by a customer, (4) level of macroeconomic uncertainty prevailing at the time of customers’ QEAs; and decreasing in suppliers’ earnings persistence. We also find that the information contained in customers’ QEAs leads to both a revision in beliefs about the level of suppliers’ future earnings, as well as to a resolution of uncertainty about such earnings. Our study adds to the literature which seeks to understand the economic factors that lead to cross-sectional differences in earnings informativeness. However, unlike prior studies which have focused on examining the factors that determine “own-firm” stock price reactions to earnings, we identify the economic factors that lead to cross-sectional differences in the informativeness of one firm’s earnings (e.g., a customer’s) to investors of a another, non-announcing firm (e.g., a supplier). Our study also extends prior research by documenting that information externalities are not limited to firms in the same industry but also extend to firms in the supply chain.

Inefficiencies in the Information Thicket: A Case Study of Derivative Disclosures During the Financial Crisis

Conventional wisdom concerning the causes of the Financial Crisis posits that insufficient disclosure concerning firms’ exposure to complex credit derivatives played a key role in creating the uncertainty that plagued the financial sector in the fall of 2008. To help avert future financial crises, regulatory proposals aimed at containing systemic risk have accordingly focused on enhanced derivative disclosures as a critical reform measure. A central challenge facing these proposals, however, has been understanding whether enhanced derivative disclosures can have any meaningful effect given the complexity of credit derivative transactions.This Article provides an empirical examination of the effect of enhanced derivative disclosures by examining the disclosure experience of the monoline insurance industry in 2008. Like AIG Financial Products, monoline insurance companies wrote billions of dollars of credit default swaps on multi-sector CDOs tied to residential home mortgages, but unlike AIG, their unique status as financial guarantee companies subjected them to considerable disclosure obligations concerning their individual credit derivative exposures. As a result, the experience of the monoline industry during the Financial Crisis provides an ideal setting with which to test the efficacy of reforms aimed at promoting more elaborate derivative disclosures.Overall, the results of this study indicate that investors in monoline insurers showed little evidence of using a firm’s derivative disclosures to efficiently resolve uncertainty about a monoline’s exposure to credit risk. In particular, analysis of the abnormal returns to Ambac Financial (one of the largest monoline insurers) surrounding a series of significant, multi-notch rating downgrades of its insured CDOs reveals no significant stock price reactions until Ambac itself announced the effect of these downgrades in its quarterly earnings announcements. Similar analyses of Ambac’s short-selling data and changes in the cost of insuring Ambac debt securities against default also confirm the absence of a market reaction following these downgrade announcements. Following a qualitative examination of how investors process derivative disclosures, the Article concludes that to the extent the complexity of CDOs impeded informational efficiency, it was most likely due to the generally low salience of individual CDOs as well as the logistic (although not necessarily analytic) challenge of processing a CDO’s disclosures. Reform efforts aimed at enhancing derivative disclosures should accordingly focus on mechanisms to promote the rapid collection and compilation of disclosed information as well as the psychological processes by which information obtains salience.

The Market’s Reaction to Unexpected Earnings Thresholds

We examine differences in quarterly earnings announcement returns as a function of meeting or missing each of three earnings thresholds – reporting a profit, reporting an increase in earnings, and meeting analysts’ forecasts. In contrast to prior research, the research design identifies the incremental market reaction to the profit and earnings increase thresholds, after controlling for the effect of meeting or missing analysts’ forecasts. Using this methodology, we find little evidence of incremental threshold effects beyond meeting analyst forecasts. In other words, zero earnings and a zero change in earnings do not appear to be “special” points that elicit a differential response by investors. Our results are robust to including a number of control variables and alternative tests. The fact that we find little evidence to support market-related incentives to manage earnings at the profit and earnings increase thresholds suggests either that managers have other incentives to manage earnings at these thresholds or that managers perceive market rewards and penalties when none exist.

How markets react to earnings announcements in the absence of analysts and institutions: evidence from the Saudi market

How stock markets react to news is an established area of research. We examine the behaviour of the Saudi Stock Market (SSM) in response to quarterly earnings announcements where there are no analysts' forecasts, with the aim of examining the efficiency of the market. The SSM seems to underreact to positive news for the first five days and then reactions tend to strengthen in the following weeks, indicating the presence of a Post-Earnings Announcement Drift (PEAD). At the same time, the SSM overreacts to negative news in the first five days and then reverses its direction and reports an upward PEAD. The individually dominated market combined with the absence of analysts' forecasts is the main explanation for this underreaction to positive news and overreaction to negative news.

Disclosure of allegedly illegal corporate activities and information risk

Abstract We investigate how the disclosure of allegedly illegal corporate activities such as the backdating of stock option grants affects the “information risk” of accused companies. This research provides evidence about the consequences of this risk change on equity values. We compare the earnings' response coefficients (ERC) for companies charged with backdating before and after it was revealed that these companies allegedly engaged in these activities. Our results show a U-shape pattern in ERC across post-backdating periods, suggesting a temporary decline in information risk. We also estimate the amount of company valuation losses that are based on the changes in the ERC. We find, on average, that a firm suffered approximately $26.2 million in valuation losses for four quarterly earnings announcements in the post-backdating period. Our economic significance analysis suggests that valuation losses related to changes in “information risk” provide some explanations for the subsequent market valuation consequences.

Geographic earnings disclosure and trading volume

Beginning with Statement of Financial Accounting Standards No. 131 (SFAS 131), Disclosures about Segments of an Enterprise and Related Information, most US multinational firms no longer disclose geographic earnings in their annual reports. Given the recent growth in foreign operations of US firms and the varying operating environments around the world, information (or lack thereof) related to geographical performance can affect investors’ information set. Using empirical tests that closely follow the [Kim, O., Verrecchia, R., 1997. Pre-announcement and event-period private information. Journal of Accounting and Economics 24, 395–419] model, we find results consistent with their predictions. Specifically, using a sample of firms with substantial foreign operations, we find evidence of a decrease in event period private information following adoption of SFAS 131 for firms that no longer disclose geographic earnings. These results suggest that decreased public information (i.e., non-disclosure of geographic earnings) reduces the ability of investors to utilize or generate private information in conjunction with the public announcement of quarterly earnings, which dampens trading. We also find evidence of a decrease in pre-announcement private information following adoption of SFAS 131. This is consistent with an overall improvement in public disclosures that has the effect of reducing differences in the precision of private information across investors in the period prior to the earnings announcement. However, such an effect is observed for both firms which no longer disclose geographic earnings and for firms that continue to disclose geographic earnings.

Information Transfers among Group-Affiliated Firms

This study examines intra-group information transfers associated with quarterly earnings announcements. Specifically, the objectives of this paper are to investigate whether there is positive information transfers among group-affiliated firms, and to examine how the affiliate’s operating strategy affect the extent of information transfers. The sample includes 615 quarterly earnings releases by firms listed in Taiwan Stock Exchange between 1988 and 1997. The empirical results provide evidence of positive information transfers between affiliated firms associated with quarterly earnings announcements. In addition, the extent of information transfer is dependent on the diversification strategies of the group affiliates. When industry covariation in firms' returns is removed, directional information transfers remain significant. Keywords: Group-affiliated Firms, Information Transfer, Quarterly Earnings Announcement, Market model, Two-index Model

The Unappreciated Value of Marketing: The Moderating Role of Changes in Marketing and R&D Spending on Valuation of Earnings Reports

Because current earnings predict future financial performance, the stock market reacts strongly to earnings announcements. How rapidly and in what manner information about marketing actions and strategies is accounted for in the stock valuation is less clear. We examine the financial market's ability to fully and timely value marketing-related information released along with quarterly earnings announcements. We find evidence consistent with the market initially under-appreciating marketing and R&D effort. Specifically, we find differences in the immediate market response to earnings announcements for firms expanding versus reducing their marketing and R&D effort. However, we also observe a significantly greater positive stock price drift (i.e., systematic stock price adjustment) in the months following an earnings announcement for firms increasing marketing and/or R&D expenditures. We examine the dynamics and the mechanism underlying this differential drift. Firms increasing their marketing and/or R&D spending report significantly greater future operating performance than firms decreasing their marketing and R&D spending and the stock price adjustment (drift) accelerates around the time of the subsequent earnings announcement. Our findings suggest that the stock market takes time to fully incorporate implications of strategic marketing decisions. They also suggest the stock market tends to update firm valuation when the outcomes of marketing strategies are realized in future financial performance and new performance signals are sent to the market.

Short Sales and Post Earnings Announcement Drift

Using intraday transactions data including short sales, I study short-selling around quarterly earnings announcements and linkages between short sales and post earnings announcement stock returns. Short sales increase immediately after both negative and positive earnings surprises. Furthermore, patterns in shorting at subsequent surprises in series of same-sign earnings surprises suggest that short sellers exploit the consequences of other investors' behavioral biases. The results highlight motivations for short sales after earnings announcements, and illustrate how short-selling contributes to market efficiency after positive (but not negative) earnings surprises.

The Information Content of Quarterly Earnings in Syndicated Bank Loan Prices

This paper examines the information content of quarterly earnings announcements in the syndicated bank loan market by focusing on the private release of earnings information to loan syndicate members. In contrast to the literature on equity price reactions to earnings announcements, we find significant price movements in the secondary loan market four to five weeks prior to public earnings announcement dates, around the time of mandated covenant reports to members of the syndicate. This paper finds that the loan market reaction to private information about earnings is asymmetric, such that loan returns decline when earnings decline, but there is no significant loan market reaction to earnings increases. The results are robust to controlling other earnings pre-announcement information.

The Changing Nature of Trading Volume Reactions to Earnings Announcements: Further Evidence of an Increase in Pre-Announcement Private Information

We document a change in the nature of trading volume reactions to quarterly earnings announcements over the time period 1976-2005. Consistent with Landsman and Maydew (2002), we find that the magnitude of abnormal trading volume around quarterly earnings announcements has increased over time and that this increase is greater for large firms than small firms. We show, however, that this trend has reversed the negative relation between firm size and trading volume documented by Bamber (1987). Applying insights from recent trading volume theory, we predict and provide evidence that the increase in abnormal trading volume across time and firm size is due to increases in pre-announcement private information. Specifically, we show that the component of abnormal trading volume associated with price change, which theory suggests reflects pre-announcement private information, is increasing across time and firm size. Our results suggest that investors are motivated to acquire private information prior to earnings announcements about firms that have relatively high quality information environments. Thus, our results have implications for policies aimed at reducing information asymmetry between investors by increasing public disclosure.

Are stewardship and valuation usefulness compatible or alternative objectives of financial accounting

In their joint framework project, the FASB and the IASB recently proposed dropping stewardship as one of the objectives of financial accounting, because the Boards view stewardship and valuation usefulness as compatible sub-objectives ranking under an overall objective of decision usefulness. This paper puts this conjecture to an empirical test. As it is widely agreed that asymmetric timely earnings increase the contractual efficiency of accounting information, I first test whether firms with more asymmetric timely earnings produce more valuation-useful financial accounting information. Second, I test whether firms with more influential non-equity stakeholders provide more valuation-useful financial accounting information. As non-equity stakeholders face higher transaction costs when diversifying unsystematic risk compared to equity stakeholders and as stewardship-related risks should be at least in part unsystematic, I expect the demand for stewardship-related accounting information to increase with the influence of non-equity stakeholders. Using a broad sample of U.S. firms and a set of firm-specific metrics for valuation usefulness based on short-window capital market reactions to quarterly earnings announcements, I document that the valuation usefulness of financial accounting information is consistently negatively related to its stewardship-orientation. I conclude from these analyses that valuation usefulness and stewardship are alternative objectives of financial accounting.

What do the S&P 500 Disclose in Their Earnings Announcements? Evidence on Financial Statements and Non-GAAP Financial Measures

The recent increase in the usefulness of earnings announcements is associated with the disclosure of income statements (Francis et al., 2002) and non-GAAP financial measures (Collins et al., 2005). This paper extends these results by investigating the disclosure and informativeness of non-GAAP financial statements and certain aspects of the disclosure of non-GAAP financial measures, analyzing quarterly earnings announcements' press releases of a sample of S&P500 firms during the 2001-2003 period. There are three main results. First, both the reconciliation and the non-GAAP consolidated statement of income have information content. Second, the study of the patterns of firms' disclosure of non-GAP financial measures indicates that out of 358 firms, 68% disclosed some non-GAAP financial measure in all the three years - thus, contrary to what was suggested by previous research (e.g.: Allee et al, 2007), this disclosure is not sporadic. Finally, an analysis of the emphasis given to non-GAAP financial measures indicates that, in 2003, the relative emphasis is significantly higher in the cases where the GAAP earnings number does not reach a certain threshold but the non-GAAP earnings number does. This suggests that managers respond to economic motivations when deciding how much emphasis should de given to non-GAAP earnings.

Deductio Ad Absurdum: CEOs Donating Their Own Stock to Their Own Family Foundations

I study large charitable gifts by Chairmen and CEOs of public companies using their own company stock as the donation currency. Unlike open market sales, gifts of stock are not subject to insider trading law and have very lenient disclosure requirements.Consistent with their exemption from insider trading law, I find that CEOs' stock gifts occur just prior to significant drops in their firms' stock prices, a pattern that enables the donors to obtain increased personal income tax benefits. This timing is more pronounced when executives donate their own shares to their own family foundations, which I identify using foundations' IRS tax returns posted on Internet databases. Stock gifts are also strategically timed to occur prior to unfavorable quarterly earnings announcements and after positive earnings announcements.Evidence related to reporting delays and seasonal patterns suggests that some CEOs backdate stock gifts to their own family foundations in order to increase personal tax benefits.CEOs' family foundations hold donated stock for long periods rather than diversifying, permitting CEOs to continue voting the shares but violating standard prudent investor principles of risk reduction through diversification.These results highlight an odd juxtaposition of motives, suggesting that while making charitable contributions to support good works in society, CEOs use aggressive and perhaps fraudulent tax evasion strategies.