Surprises Bibliography

Abarbanell, J. and V. L. Bernard. 1992. Tests of Analysts’ Overreaction/Underreaction to Earnings Information as an Explanation for Anomalous Stock Price Behavior. The Journal of Finance 47 (3): 1181-1207.

This study examines whether security analysts underreact or overreact to prior earnings information, and whether any such behavior could explain previously documented anomalous stock price movements. We present evidence that analysts’ forecasts underreact to recent earnings. This feature of the forecasts is consistent with certain properties of the naive seasonal random walk forecast that Bernard and Thomas (1990) hypothesize underlie the well-known anomalous post-earnings-announcement drift. However, the underreactions in analysts’ forecasts are at most only about half as large as necessary to explain the magnitude of the drift. We also document that the “extreme” analysts’ forecasts studied by DeBondt and Thaler (1990) cannot be viewed as overreactions to earnings, and are not clearly linked to the stock price overreactions discussed in DeBondt and Thaler (1985, 1987) and Chopra, Lakonishok, and Ritter (Forthcoming). We conclude that security analysts’ behavior is at best only a partial explanation for stock price underreaction to earnings, and may be unrelated to stock price overreactions.

Ali, A., S. Klasa, and O. Li. 2009. Institutional stakeholdings and better-informed traders at earnings announcements. Journal of Accounting and Economics forthcoming.

Utama and Cready [Utama, S., Cready, W.M., 1997. Institutional ownership, differential predisclosure precision and trading volume at announcement dates. Journal of Accounting and Economics 24, 129–150] use total institutional ownership to proxy for the proportion of better-informed traders, an important determinant of trading around earnings announcements. We argue that institutions holding small stakes cannot justify the fixed cost of developing private predisclosure information. Also, institutions with large stakes generally do not trade around earnings announcements since they are dedicated investors or face regulations that make informed trading difficult. However, institutions holding medium stakes have incentives to develop private predisclosure information and trade on it; we show that their ownership is a finer proxy for the proportion of better-informed traders at earnings announcements.

Ali, A., X. Chen, T. Yao, and T. Yu. 2007. Riding the post earnings announcement drift: Mutual fund trades, market frictions, and market efficiency. Working Paper.

This paper uses portfolio holdings and returns of mutual funds to study whether investors can profitably trade on the post earnings announcement drift (PEAD). We find that actively-managed US equity mutual funds on average trade on PEAD, even after controlling for different investment styles and momentum trading. Further, trading on PEAD is profitable: net of both transaction costs and fund expenses, the annual Carhart (1997) four-factor alpha of the top 10% of funds most actively following the PEAD strategy is 2.10% higher than that of a group of benchmark funds not actively using the strategy. However, across funds, more active trading on PEAD is associated with less portfolio diversification, higher volatility in fund returns and higher volatility in fund flows, representing adverse consequences of arbitrage risk. Finally, we document the temporal dynamics between fund trading and the profitability of the PEAD strategy: higher profitability attracts more intense trading by funds, which, in turn, leads to lower future profitability.

Baker, M., L. Litov, J. A. Wachter, and J. Wurgler. 2010. Can Mutual Fund Managers Pick Stocks? Evidence from Their Trades Prior to Earnings Announcements. Journal of Financial and Quantitative Analysis 45: 1111-1131.

Recent research finds that the stocks that mutual fund managers buy outperform the stocks that they sell (e.g., Chen, Jegadeesh, and Wermers (2000)). We study the nature of this stock-picking ability. We construct measures of trading skill based on how the stocks held and traded by fund managers perform at subsequent corporate earnings announcements. This approach increases the power to detect skilled trading and sheds light on its source. We find that the average fund’s recent buys significantly outperform its recent sells around the next earnings announcement, and that this accounts for a disproportionate fraction of the total abnormal returns to fund trades estimated in prior work. We find that mutual fund trades also forecast earnings surprises. We conclude that mutual fund managers are able to trade profitably in part because they are able to forecast earnings-related fundamentals.

Balakrishnan, K., E. Bartov, and L. Faurel. 2010. Post loss/profit announcement drift. Journal of Accounting and Economics 50: 20-41.

We document a market failure to fully respond to loss/profit quarterly announcements. The annualized post portfolio formation return spread between two portfolios formed on extreme losses and extreme profits is approximately 21 percent. This loss/profit anomaly is incremental to previously documented accounting-related anomalies, and is robust to alternative risk adjustments, distress risk, firm size, short sales constraints, transaction costs, and sample periods. In an effort to explain this finding, we show that this mispricing is related to differences between conditional and unconditional probabilities of losses/profits, as if stock prices do not fully reflect conditional probabilities in a timely fashion.

Ball, R. and P. Brown. 1968. An Empirical Evaluation of Accounting Income Numbers. Journal of Accounting Research 6 (2): 159-178.

Abstract unavailable

Ball, R., 1992. The earnings–price anomaly. Journal of Accounting and Economics 15, 319–345.

This review explores systematic explanations for the anomalous evidence in the relation between accounting earnings and stock prices. The anomaly is that estimated future abnormal returns are predicted by public information about future earnings, contained in (1) current earnings and (2) current financial statement ratios. The current-earnings anomaly appears due to either market inefficiency or substantial costs of investors acquiring and processing information, the choice depending on one’s priors concerning these costs and one’s definition of market ‘efficiency’. The financial-statement-information anomaly appears due to accounting ratios proxying for stocks’ expected returns. Anomaly seems likely to be a permanent state.

Ball, R., S. P. Kothari, and R. L. Watts. 1993. Economic Determinants of the Relation between Earnings Changes and Stock Returns. The Accounting Review 68 (3): 622-638.

In competitive product markets, product prices and thus firms’ revenues incorporate the cost of equity capital. In a competitive capital market, the cost of equity capital (the expected return on equity) increases with the risk of firms’ investments. Because accounting earnings are calculated without deducting the cost of equity capital, they are expected to be an increasing function of firms’ investment risks. This simple competitive equilibrium analysis predicts a positive relation between changes in investment risk and expected earnings. The presence of corporate debt complicates the analysis because leverage effects seem likely to affect the relation between changes in investment risk and expected earnings. Using annual earnings and return data from 1950 to 1988, we document a statistically significant positive association between changes in equities’ relative risks and in earnings. However, on average, only a small proportion of changes in earnings can be attributed to changes in risk. A much larger proportion is attributable to changes in economic rents (windfall gains and losses). The observed positive association between changes in earnings and changes in equities’ risks suggests that leverage effects do not fully offset the effect of changes in investment risks. This association is robust with respect to subperiod analysis, alternative specifications of the earnings change variable, alternative data-availability requirements, and the number of portfolios formed.

Barber, B. and T. Odean. 2000. Trading is hazardous to your wealth: the common stock investment performance of individual investors. Journal of Finance 55 (2): 773-806.

Individual investors who hold common stocks directly pay a tremendous performance penalty for active trading. Of 66,465 households with accounts at a large discount broker during 1991 to 1996, those that trade most earn an annual return of 11.4 percent, while the market returns 17.9 percent. The average household earns an annual return of 16.4 percent, tilts its common stock investment toward high-beta, small, value stocks, and turns over 75 percent of its portfolio annually. Overconfidence can explain high trading levels and the resulting poor performance of individual investors. Our central message is that trading is hazardous to your wealth.

Barber, B., T. Odean, and N. Zhu. 2009. Do retail traders move markets? Review of Financial Studies 22: 151-186.

We study the trading of individual investors using transaction data and identifying buyer- or seller-initiated trades. We document four results: (1) Small trade order imbalance correlates well with order imbalance based on trades from retail brokers. (2) Individual investors herd. (3) When measured annually, small trade order imbalance forecasts future returns; stocks heavily bought underperform stocks heavily sold by 4.4 percentage points the following year. (4) Over a weekly horizon, small trade order imbalance reliably predicts returns, but in the opposite direction; stocks heavily bought one week earn strong returns the subsequent week, while stocks heavily sold earn poor returns.

Barron, O., Harris D.G., Stanford, M. (2005) Evidence That Investors Trade on Private Event-Period Information Around Earnings Announcements. The Accounting Review.

Holthausen and Verrecchia’s (1990) and Kim and Verrecchia’s (1997) theoretical models predict that private information inferred at the time of an earnings announcement (private event-period information) is associated with greater trading volume. We provide empirical evidence consistent with these theories. Specifically, announcements that increase analysts’ private information (as measured by Barron, et al.’s 1998 empirical proxies) are associated with increased trading volume, consistent with some investors similarly acquiring private event-period information. In addition, announcements that decrease analysts’ consensus are associated more trading volume. Because consensus declines when private information increases, this finding provides reinforcing evidence that investors trade following earnings announcements because of private information that becomes useful only in conjunction with the information in the announcement and that this information is important enough to spur trading. Empirically, our analyses demonstrate that our theoretically-derived measures of analysts’ private information and consensus remain significant after controlling for other determinants of trading volume documented in prior research (e.g., change in dispersion of analysts’ forecasts, belief jumbling, earnings surprise, and firm size).

Barth, M., I. D. Gow, and D. J. Taylor. 2010. Non-GAAP and Street Earnings: Evidence from SFAS123R. Working Paper.

This study examines how key market participants – managers and analysts – responded to SFAS 123R’s controversial requirement that firms recognize stock-based compensation expense. Despite mandated recognition of the expense, some firms’ managers exclude it from non-GAAP earnings and some firms’ analysts exclude it from Street earnings. We find evidence consistent with managers opportunistically excluding the expense to increase earnings, smooth earnings, and meet earnings benchmarks, but no evidence that such exclusion results in an earnings measure that better predicts future firm performance. In contrast, we find that analysts exclude the expense from earnings forecasts when the exclusion increases earnings’ predictive ability for future performance, but opportunism generally does not incrementally explain exclusions by analysts. Thus, we find that opportunism explains exclusion of the expense from non-GAAP earnings and predictive ability explains exclusion from Street earnings. Our findings suggest the controversy surrounding the recognition of stock-based compensation expense may be attributable to cross-sectional variation in the relevance of the expense for equity valuation, as well as to differing incentives of market participants.

Bartov, E., S. Radhakrishnan, and I. Krinsky. 2000. Investor sophistication and patterns in stock returns after earnings announcements. The Accounting Review 75: 43-63.

This study tests whether the observed patterns in stock returns after quarterly earnings announcements are related to the proportion of firm shares held by institutional investors, a variable used by prior research to proxy for investor sophistication. Our findings show that the institutional holdings variable is negatively correlated with the observed post-announcement abnormal returns. Our findings also show that traditional proxies for transaction costs (i.e., trading volume, stock price) as well as firm size have little incremental power to explain post announcement abnormal returns when institutional holdings is an explanatory variable. If institutional ownership is a valid proxy for investor sophistication, these findings suggest that the trading activity of unsophisticated investors underlies the predictability of stock returns after earnings announcements. However, tests evaluating the validity of institutional holdings as a proxy for investor sophistication yield only mixed results. This calls for caution in interpreting our findings.

Battalio, R. and R. Mendenhall. 2007. Post-earnings Announcement Drift: Intra-day Timing and Liquidity Costs. Working Paper.

The persistence of the post-earnings announcement drift leads many to believe that trading barriers prevent knowledgeable investors from eliminating it. For example, Bhushan (1994) contends that sophisticated investors quickly drive prices to within trading costs of efficient values. We examine two factors not previously addressed in the literature: the exact timing of the announcements and liquidity costs. Specifically, we compare the profits generated by transacting immediately following the announcement and at the close of the actual announcement day to the common practices of assuming trades at the close on the Compustat date or the following day. We further investigate the impact of liquidity costs on the drift by examining actual quotes available to investors. Under a wide range of timing and cost assumptions our results leave little doubt that between 1993 and 2002 an investor could have earned hedged-portfolio returns of at least 14% per year after trading costs.

Bauman, M.P., Shaw, K.W.  (2006) Stock option compensation and the likelihood of meeting analysts’ quarterly earnings targets. Review of Quantitative Finance and Accounting.

One role of stock options in executive compensation packages is to counterbalance the inherently short-term orientation of base salary and annual bonuses. Managerial compensation plans frequently include stock options in order to better align the interests of managers and outside shareholders and reduce agency problems. However, since option values are sensitive to fluctuations in stock prices, and investors reward firms that meet or exceed earnings expectations, executives of firms with sizable option components in their compensation plans have increased incentives to report earnings that meet or exceed analysts’ forecasts. We show that the propensity to meet or exceed analysts’ quarterly earnings forecasts are positively related to the use of options in top executives’ compensation plans. Further, firms that employ relatively more options in their compensation plans more frequently report earnings surprises that exceed analysts’ forecast by small amounts (between 0 and 1 cent per share). These results suggest that the use of stock-based compensation intensifies top executives’ focus on financial analysts’ short-term earnings forecasts.

Benos, Alexandros and Rockinger, Michael 2000, Market Response to Earnings Announcements and Interim Reports: An Analysis of SBF120 Companies, Annales d’Économie et de Statistique, No. 60, Microstructure des marchés financiers / Financial Market Microstructure (Oct. – Dec., 2000), pp. 151-175.

Starting in 1995, we follow for three years the 120 most important companies listed on the Paris Bourse and examine the link between stock trading characteristics and different measures of earnings’ surprises during annual and semi-annual public disclosures. After a short discussion of market organization and the regulation of financial disclosure in France, we assess intraday data to find analysts are overly optimistic of EPS and small companies are less analyzed than large ones. Studying further the evolution of portfolios sorted according to various unexpected earnings’ criteria we find that, in some cases, there is a small pre-announcement drift. The study further reveals that there is a strong negative drift in prices before a negative EPS announcement and bad news agitate markets more than good news. More importantly, we find the market responds to a hierarchy of announcement surprises: a positive EPS is not enough to make investors bullish if it is decreasing. Even an increasing EPS is not enough if analysts’ expectations are not met. Finally, prices adjust very quickly to public information but there is an imbalance between volume and trading intensity for the time necessary to settle back to their normal levels. This suggests institutional investors follow news more closely than small investors.

Bernard, V. and J. K. Thomas. 1989. Post-Earnings-Announcement Drift: Delayed Price Response or Risk Premium? Journal of Accounting Research 27: 1-36.

The article focuses on the delayed price response in post-earnings-announcement drift. It states that competing explanations for post-earnings-announcement drift can be placed in two categories: price response to new information is delayed, and that researches fail to adjust raw returns fully for risk due to the use of incomplete or misestimated capital-asset-pricing models (CAPM) to calculate abnormal returns. It summarizes the current state of understanding for post-earnings-announcement drift and comments on delayed price response and CAPM misspecification to explain the drift. It examines the sample and some of the methods used in empirical tests.

Bernard, V., Thomas, J., 1990. Evidence that stock prices do not fully reflect the implications of current earnings for future earnings. Journal of Accounting and Economics 13, 305–340.

Evidence presented here is consistent with a failure of stock prices to reflect fully the implications of current earnings for future earnings. Specifically, the three-day price reactions to announcements of earnings for quarters t + 1 through t + 4 are predictable, based on earnings of quarter t. Even more surprisingly, the signs and magnitudes of the three-day reactions are related to the autocorrelation structure of earnings, as if stock prices fail to reflect the extent to which each firm’s earnings series differs from a seasonal random walk.

Billet, Matthew, Mark Flannery, and Jon Garfinkel, 2006, Are bank loans special? Evidence on the post-announcement performance of bank borrowers, Journal of Financial and Quantitative Analysis 41, 733-752.

Unlike seasoned equity or public debt offerings, bank loan financing elicits a significantly positive announcement return, which has led financial economists to characterize bank loans as “special.” Here, we find that firms announcing bank loans suffer negative abnormal stock returns over the subsequent three years. In the long run, bank loans appear no different from seasoned equity offerings or public debt issues. Our evidence suggests that larger loans (relative to borrower equity) are followed by worse stock performance. We also find that lender protection is negatively related to borrower performance, suggesting the lender is somewhat shielded from the poor performance.

Bloomfield, R., R. Libby, and M. Nelson. 1999. Confidence and the welfare of less-informed investors, Accounting, Organizations, and Society 24: 623-647.

In response to recommendations by the AICPA Special Committee on Financial Reporting and the Association for Investment Management and Research, the FASB recently invited comment regarding the question, “Given [efficient] markets, would any disservice be done to the interests of individual investors by allowing professional investors access to more extensive information?” [AICPA (1996) Report of the Special Committee on Financial Reporting and the Association for Investment Management and Research, New York, p. 22]. Research in psychology [e.g. Griffin & Tversky (1992) The weighing of evidence and the determinants of confidence. Cognitive Psychology, 411–435] suggests that less-informed investors may suffer from over-confidence and trade too aggressively given their information. This paper reports on an experiment designed to address these issues. In the experiment, security values are determined by the price/book ratios of actual firms, “more-informed” investors observe three value-relevant financial ratios derived from Value-Line reports, and “less-informed” investors observe only one of those signals. Even after market prices have stabilized after many rounds of trading, less-informed investors systematically transfer wealth to more-informed investors as a result of biased prices and overly aggressive trading. However, alerting less-informed investors to the extent of their informational disadvantage eliminates these welfare losses. The results thus suggest that providing information to only professional investors could harm the welfare of less-informed investors if less-informed investors are not aware of the extent of their informational disadvantage.

Bradshaw, M. T. and R. G. Sloan. 2002. GAAP versus the Street: An empirical assessment of two alternative definitions of earnings. Journal of Accounting Research 40 (1): 41-66.

Managers, security analysts, investors, and the press rely increasingly on modified definitions of GAAP net income, known by such names as “operating” and “pro forma” earnings. We document this phenomenon and discuss competing explanations for the recent rise in the use of such modified earnings numbers and implications for the interpretation of related accounting research. Our results show that over the past 20 years there has been a dramatic increase in the frequency and magnitude of cases where “GAAP” and “Street” earnings differ. Further, there is a very strong bias toward the reporting of a Street earnings number that exceeds the GAAP earnings number. We also show that the market response to the Street earnings number has displaced GAAP earnings as a primary determinant of stock prices. Finally, through an analysis of earnings releases, we show that management has taken a proactive role in defining and emphasizing the Street number when communicating to analysts and investors.

Brandt, M., R. Kishore, P. Santa-Clara, and M. Venkatachalam. 2008. Earnings Announcements are Full of Surprises. Working Paper.

We study the drift in returns of portfolios formed on the basis of the stock price reaction around earnings announcements. The Earnings Announcement Return (EAR) captures the market reaction to unexpected information contained in the company’s earnings release. Besides the actual earnings news, this includes unexpected information about sales, margins, investment, and other less tangible information communicated round the earnings announcement. A strategy that buys and sells companies sorted on EAR produces an average abnormal return of 7.55% per year, 1.3%more than a strategy based on the traditional measure of earnings surprise, SUE. The post earnings announcement drift for EAR strategy is stronger than post earnings announcement drift for SUE. More importantly, unlike SUE, the EAR strategy returns do not show a reversal after 3 quarters. The EAR and SUE strategies appear to be independent of each other. A strategy that exploits both pieces of information generates abnormal returns of about 12.5% on an annual basis.

Brown, L., Caylor, M. (2005) A temporal analysis of quarterly earnings thresholds: Propensities and valuation consequences. The Accounting Review.

Applying a Burgstahler and Dichev (1997)/Degeorge et al. (1999) type methodology to quarterly data for the 1985-2002 time period, we show that, since the mid-1990s, but not before then, managers seek to avoid negative quarterly earnings surprises more than to avoid either quarterly losses or quarterly earnings decreases. Our findings suggest that the quarterly earnings threshold hierarchy proposed by Degeorge et al. (1999) does not apply to recent years, and that managers’ claim that avoiding quarterly earnings decreases is the threshold they most seek to achieve (Graham et al. 2004) is inconsistent with their actions. We provide an intuitively appealing economic rationale for why the shift in threshold hierarchy occurred; since the mid-1990s, but not before then, investors unambiguously rewarded (penalized) firms for reporting quarterly earnings meeting (missing) analysts’ estimates more than they did for meeting (missing) the other two thresholds. We provide several explanations for why investors unambiguously reward firms for reporting quarterly earnings that meet or beat analysts’ estimates more than for meeting the other two thresholds late (but not early) in our sample period: increased media coverage given to analyst forecasts, more analyst following, more firms covered by analysts, and temporal increases in both the accuracy and precision of analyst forecasts.

Burgstahler, D., Eames, M. (2006) Management of earnings and analysts’ forecasts to achieve zero and small positive earnings surprises.  Journal of Business, Finance and Accounting.

This paper corroborates the finding of prior studies that managers avoid reporting earnings lower than analyst forecasts (i.e., negative earnings surprises) and provides new evidence of actions contributing to this phenomenon. Specifically, we provide empirical evidence of both (1) upward management of reported earnings and (2) downward ‘management’ of analysts’ forecasts to achieve zero and small positive earnings surprises. Further analysis of the components of earnings management suggests that both the operating cash flow and discretionary accruals components of earnings are managed.

Bushee, B. and J. S. Raedy. 2005. Factors Affecting the Implementability of Stock Market Trading Strategies. Working Paper.

A substantial body of academic literature provides evidence of stock market trading strategies that generate appreciable abnormal returns. However, there are a number of factors that could partially or fully mitigate the ability of market participants to implement these trading strategies, such as price pressure, restrictions against short sales, and incentives to hold no more than 5% ownership in a firm. We investigate the extent to which these factors account for the evidence of abnormal returns found in seven trading strategies documented in prior research. We find that the size and return reversal trading strategies do not perform well in the presence of the various constraints, whereas the cash flow-to-price, return momentum, post-earnings announcement drift, and operating accrual strategies generally continue to generate significant positive abnormal returns. We find that the book-to-market strategy generates significant positive abnormal returns in about 50% of the scenarios we examine. We find that all of the strategies generate positive abnormal returns in the presence of the restriction against short sales, but that price impact adjustments and constraints on holding more than a 5% stake in any portfolio firm each have a large negative effect on portfolio returns. We also find that equally-weighted portfolio allocations generally perform better than value-weighted allocations and funds with a greater number of stocks and/or lower initial market capitalization also generally produce higher returns. Finally, we find that portfolios that engage in short positions perform worse than long-only portfolios due primarily to the sustained increase in stock prices during the sample period.

Campbell, J. Y., T. Ramadorai, and A. Schwartz. 2009. Caught on tape: Institutional trading, stock returns, and earnings announcements. Journal of Financial Economics 92: 66-91.

Many questions about institutional trading can only be answered if one tracks high-frequency changes in institutional ownership. In the United States, however, institutions are only required to report their ownership quarterly in 13-F filings. We infer daily institutional trading behavior from the “tape”, the Transactions and Quotes database of the New York Stock Exchange, using a sophisticated method that best predicts quarterly 13-F data from trades of different sizes. We find that daily institutional trades are highly persistent and respond positively to recent daily returns but negatively to longer-term past daily returns. Institutional trades, particularly sells, appear to generate short-term losses—possibly reflecting institutional demand for liquidity—but longer-term profits. One source of these profits is that institutions anticipate both earnings surprises and post-earnings announcement drift. These results are different from those obtained using a standard size cutoff rule for institutional trades.

Chan, L. K. C., N. Jegadeesh, and J. Lakonishok. 1996. Momentum Strategies. Journal of Finance 51: 1681-1713.

We examine whether the predictability of future returns from past returns is due to the market’s underreaction to information, in particular to past earnings news. Past return and past earnings surprise each predict large drifts in future returns after controlling for the other. Market risk, size, and book-to-market effects do not explain the drifts. There is little evidence of subsequent reversals in the returns of stocks with high price and earnings momentum. Security analysts’ earnings forecasts also respond sluggishly to past news, especially in the case of stocks with the worst past performance. The results suggest a market that responds only gradually to new information.

Chen (U Washington),  Jiambalvo (U Washington) The Relations between Dispersion in Analyst Forecasts and Stock Returns ; Optimism vs. Drift – July 2004  [ low returns if high dispersion ]

This paper investigates the conclusion in Diether, Malloy, and Scherbina (2002) that dispersion in analysts’ forecasts proxies for differences in investor beliefs, and that prices reflect the beliefs of optimistic investors when dispersion is high. If this is the case, we expect to find higher earnings response coefficients (ERCs), related to negative earnings surprises, for high versus low dispersion firms. This follows because the negative earnings surprises are less consistent with the beliefs of optimists. However, we find smaller ERCs, which calls into question the optimism argument in DMS. Further, we find that the relatively low future returns earned by high forecast dispersion firms, documented in DMS, are explained by the well known post-earnings-announcement drift phenomena. Specifically, after sorting observations based on prior period standardized unexpected earnings (SUEs), which are associated with drift, the difference between the future returns of high versus low dispersion firms is not statistically significant.

Chordia, T., A. Goyal, G. Sadka, R. Sadka, and L. Shivakumar. 2009. Liquidity and the Post-Earnings Announcement Drift. Financial Analysts Journal 65 (4): 18-32.

The post-earnings-announcement-drift is a long standing anomaly that is in conflict with market efficiency. This paper documents that the post-earnings-announcement drift occurs mainly in the highly illiquid stocks. A trading strategy that goes long the high earnings surprise stocks and short the low earnings surprise stocks provides a value-weighted return of 0.14% in the most liquid stocks and 1.60% per month in the most illiquid stocks. The illiquid stocks have high trading costs and market impact costs. Using a multitude of estimates we find that transaction costs account for anywhere from 63% to 100% of the paper profits from the long-short strategy designed to exploit the earnings momentum anomaly. This paper provides support for the argument that transactions costs could be the source of the drift.

Chordia, T., and L. Shivakumar. 2005. Inflation illusion and post-earnings-announcement drift. Journal of Accounting Research 43: 521-556.

This paper examines the cross-sectional implications of the inflation illusion hypothesis for the post-earnings-announcement drift. The inflation illusion hypothesis suggests that stock market investors fail to incorporate inflation in forecasting future earnings growth rates, and this causes firms whose earnings growths are positively (negatively) related to inflation to be undervalued (overvalued). We argue and show that the sensitivity of earnings growth to inflation varies monotonically across stocks sorted on standardized unexpected earnings (SUE) and, consistent with the inflation illusion hypothesis, show that lagged inflation predicts future earnings growth, abnormal returns, and earnings announcement returns of SUE-sorted stocks. Interestingly, controlling for the return predictive ability of inflation weakens the ability of lagged SUE to predict future returns of SUE-sorted stocks.

2010 Version with Shivakumar:

We examine whether financial analysts fully incorporate expected inflation in their earnings forecasts for individual stocks. We find that expected inflation proxies, such as lagged inflation and inflation forecasts from the Michigan Survey of Consumers, predict the future earnings change of a portfolio long in high inflation exposure firms and short in low or negative inflation exposure firms, but analysts do not fully adjust for this relation. Analysts’ earnings forecast errors can be predicted using expected inflation proxies, and these systematic forecast errors are related to future stock returns. Overall, our evidence is consistent with the Chordia and Shivakumar (J Account Res 43(4):521–556, 2005) hypothesis that the post-earnings announcement drift is related to investor underestimation of the impact of expected inflation on future earnings change.

Chordia, T., and L. Shivakumar. 2006. Earnings and price momentum. Journal of Financial Economics 80: 627-656.

This paper examines whether earnings momentum and price momentum are related. Both in time-series as well as in cross-sectional asset pricing tests, we find that price momentum is captured by the systematic component of earnings momentum. The predictive power of past returns is subsumed by a zero-investment portfolio that is long on stocks with high earnings surprises and short on stocks with low earnings surprises. Further, returns to the earnings-based zero-investment portfolio are significantly related to future macroeconomic activities, including growth in GDP, industrial production, consumption, labor income, inflation, and T-bill returns.

Christensen (Brigham Young), T Smith (U New Hampshire), Stuerke (U RI) – Public Predisclosure Information , Firm Size, Analyst Following , and Market Reactions to Earnings Announcements – Journal of Business Finance & Accounting – Sept 2004

This study examines the effects of public predisclosure information on market reactions to earnings announcements. We develop an empirical measure of public predisclosure information impounded in price prior to earnings announcements by cumulating abnormal returns on public news release dates during the quarter. Consistent with prior literature, we document a negative association between this measure and market reactions to subsequent earnings announcements. Moreover, we find that after controlling for this measure, firm size and analyst following are significantly positively associated with market reactions to earnings announcements. Contrary to prior empirical evidence, our results suggest that, after controlling for actual predisclosure information impounded in price, market reactions to earnings announcements are greater in magnitude for larger, more widely-followed firms than for smaller, less widely-followed firms.

Cohen, Daniel A., Aiyesha Dey, Thomas Z. Lys and Shyam V. Sunder. (2007) Earnings announcement premia and the limits to arbitrage.

We examine the factors underlying the presence of earnings announcement premia. We find that the premia persist beyond the sample period examined in prior studies (ending in 1988), although they decline in magnitude after 1988. Further, premia are lower on the expected than the actual earnings announcement dates. We document that increases in voluntary disclosures result in lower premia, despite the increase in return volatility over time. Finally, our evidence suggests that the premia are not completely eliminated because of the costs of arbitrage.

Collins, D., and P. Hribar. 2000. Earnings-based and accrual-based market anomalies: one effect or two? Journal of Accounting and Economics 29: 101-123.

This paper investigates whether the accrual pricing anomaly documented by Sloan (1996) for annual data holds for quarterly data and whether this form of market mispricing is distinct from the post-earnings announcement drift anomaly. We find that the market appears to overestimate (underestimate) the persistence of the accrual (cash flow) component of quarterly earnings and, therefore, tends to overprice (underprice) accruals (cash flows). Moreover, the accrual (cash flow) mispricing appears to be distinct from post-earnings announcement drift. A hedge portfolio trading strategy that exploits both forms of market mispricing generates abnormal returns in excess of those based on unexpected earnings, accruals, or cash flow information alone.

Comprix, J., Mills, L., Schmidt, A. (2004) Bias in Quarterly Effective Tax Rate Estimates: Implications for Earnings Management and Analysts’ Forecasts.

We investigate whether quarterly effective tax rate estimates are systematically biased in comparison to year-end actual tax rates. We further explore whether this bias is associated with (1) subsequent revisions that allow managers to meet earnings estimates and (2) lower analysts’ forecasts that make earnings targets easier for managers to achieve. We find that first, second and third quarter effective tax rates are systematically higher than year-end, consistent with managers building slack into their estimates. On average, these rates decline monotonically each quarter. In spite of this apparent slack, we find that analysts incorporate the bias in quarterly effective tax rate into their forecasts. We also find that the apparent slack tends to be reversed when the firm would have missed its earnings forecast absent the reversal. Our findings that effective tax rate estimates are incorporated in analysts’ forecasts, and that patterns of estimates and revisions are consistent with building slack, guiding analysts’ forecasts lower and managing earnings, contribute to research about how earnings management is accomplished.

Cotter, J., Tuna, I., Wysocki, P.D., Callen, J.L. (2006) Expectations Management and Beatable Targets: How Do Analysts React to Public Earnings Guidance? Contemporary Accounting Research.

This study investigates security analysts’ reactions to public management guidance and assesses whether managers successfully guide analysts toward beatable earnings targets. We use a panel data set between 1995 and 2001 to examine the fiscal-quarter-specific determinants of management guidance and the timing, extent, and outcomes of analysts’ reactions to this guidance. We find that management guidance is more likely when analysts’ initial forecasts are optimistic, and, after controlling for the level of this optimism, when analysts’ forecast dispersion is low. Analysts quickly react to management guidance and are more likely to issue final meetable or beatable earnings targets when management provides public guidance. Our evidence suggests that public management guidance plays an important role in leading analysts toward achievable earnings targets.

Dellavigna, S. and J. Pollet. 2009. Investor Inattention and Friday Earnings Announcements. Journal of Finance 64 (2): 709-749.

Does limited attention among investors affect stock returns? We compare the response to earnings announcements on Friday, when investor inattention is more likely, to the response on other weekdays. If inattention influences stock prices, we should observe less immediate response and more drift for Friday announcements. Indeed, Friday announcements have a 15% lower immediate response and a 70% higher delayed response. A portfolio investing in differential Friday drift earns substantial abnormal returns. In addition, trading volume is 8% lower around Friday announcements. These findings support explanations of post-earnings announcement drift based on underreaction to information caused by limited attention.

Dey, M. and B. Radhakrishna. 2007. Who trades around earnings announcements? Evidence from TORQ Data. Journal of Business Finance and Accounting 34: 269-291.

Using TORQ database we investigate the intra-day trading volume reactions to earnings announcements of five trader groups, individuals, institutions, exchange members, program traders, and specialists. The results of this study indicate that institutions are most active in the immediate aftermath of an announcement. Individual investors are slow at the beginning but accumulate heavy volume afterwards and exceed institutional trading volume. We find support for Harris and Raviv (1993) and Admati and Pfleiderer (1988), who respectively argue that divergence of opinion about a public information and portfolio rebalancing cause surges in pre- and post-announcement trading volume. Further we find evidence of swift and aggressive trading by informed and sophisticated institutions in the immediate aftermath of the announcement, and delayed, aggressive trading volume ‘overreaction’ by ‘slow’ and ‘overconfident’ individual investors as documented by Barber and Odean (2000 and 2002) and Daniel et al. (1998). NYSE specialists provide the bulk of the liquidity needs around earnings announcements.

Doyle, J. T., R. J. Lundholm, and M. T. Soliman. 2003. The predictive value of expenses excluded from pro forma earnings. Review of Accounting Studies 8 (2-3): 145-174.

We investigate the informational properties of pro forma earnings. This increasingly popular measure of earnings excludes certain expenses that the company deems non-recurring, non-cash, or otherwise unimportant for understanding the future value of the firm. We find, however, that these expenses are far from unimportant. Higher levels of exclusions lead to predictably lower future cash flows. We also find that investors do not fully appreciate the lower cash flow implications at the time of the earnings announcement. A trading strategy based on the excluded expenses yields a large positive abnormal return in the years following the announcement, and persists after controlling for various risk factors and other anomalies.

Doyle, J., R. Lundholm, and M. Soliman. 2006. The Extreme Future Stock Returns Following I/B/E/S Earnings Surprises. Journal of Accounting Research 44 (5): 849-887.

We investigate the stock returns subsequent to quarterly earnings surprises, where the benchmark for an earnings surprise is the consensus analyst forecast. By defining the surprise relative to an analyst forecast rather than a time-series model of expected earnings, we document returns subsequent to earnings announcements that are much larger, persist for much longer, and are more heavily concentrated in the long portion of the hedge portfolio than shown in previous studies. We show that our results hold after controlling for risk and previously documented anomalies, and are positive for every quarter between 1988 and 2000. Finally, we explore the financial results and information environment of firms with extreme earnings surprises and find that they tend to be “neglected” stocks with relatively high book-to-market ratios, low analyst coverage, and high analyst forecast dispersion. In the three subsequent years, firms with extreme positive earnings surprises tend to have persistent earnings surprises in the same direction, strong growth in cash flows and earnings, and large increases in analyst coverage, relative to firms with extreme negative earnings surprises. We also show that the returns to the earnings surprise strategy are highest in the quartile of firms where transaction costs are highest and institutional investor interest is lowest, consistent with the idea that market inefficiencies are more prevalent when frictions make it difficult for large, sophisticated investors to exploit the inefficiencies.

Fama, E. F. 1998. Market efficiency, long-term returns, and behavioral finance. Journal of Financial Economics 49: 283-306.

Market efficiency survives the challenge from the literature on long-term return anomalies. Consistent with the market efficiency hypothesis that the anomalies are chance results, apparent overreaction to information is about as common as underreaction, and post-event continuation of pre-event abnormal returns is about as frequent as post-event reversal. Most important, consistent with the market efficiency prediction that apparent anomalies can be due to methodology, most long-term return anomalies tend to disappear with reasonable changes in technique.

Foster, G. 1977. Quarterly Accounting Data: Time-Series Properties and Predictive-Ability Results. The Accounting Review 52 (1): 1-21.

The time-series behavior of the quarterly earnings, sales and expense series of 69 firms over the 1946-74 period is examined. A Box-Jenkins time-series methodology is adopted. Based on inspection of the cross-sectional autocorrelation function, it is concluded that each series has (a) an adjacent quarter-to-quarter component and (b) a seasonal component. One-step-ahead forecasting results reveal that these two components can be successfully modeled at the individual firm level. The use of various quarterly forecasting models in security price analysis is also examined. The results are consistent with the market adjusting for seasonality in quarterly earnings in interpreting each quarter’s earnings change.

Foster, G., C. Olsen, and T. Shevlin. 1984. Earnings Releases, Anomalies, and the Behavior of Security Returns. The Accounting Review 59 (4): 574-603.

A common finding in the literature is that systematic post-announcement drifts in security returns are associated with the sign or magnitude of unexpected earnings changes. This paper examines proposed explanations for these drifts. The paper also documents that the systematic drifts in security returns are found for only a subset of earnings expectations models. For a class of expectations models based on the time series of reported quarterly earnings, variables coding (1) the sign and magnitude of the earnings forecast error and (2) firm size independently explain 81 percent and 61 percent, respectively, of the variation in post-announcement drifts. The joint explanatory power of (1) and (2) is 85 percent, indicating that the effect of these two variables is highly collinear. The drifts are a persistent phenomenon over the 1974 to 1981 period with no evidence of being concentrated in a specific subperiod. The properties of expectations models based on the time series of earnings are contrasted with earnings expectations models based on security returns. The latter exhibit no evidence of systematic post-announcement drift behavior. The expectations models based on security returns have the appealing property that the assignment of firms to unexpected earnings change portfolios better approximates the independence-over-time assumption. This property means that these models are less vulnerable to the “proxy effect” criticism that has been made of results previously reported in the literature. The results in this paper are based on a sample of over 56,000 observations covering the 1974 to 1981 time period.

Francis, J., R. Lafond, P. Olsson, and K. Schipper. 2007. Information Uncertainty and Post-Earnings-Announcement-Drift. Journal of Business Finance & Accounting 34 (3-4): 403-433.

We examine whether rational investor responses to information uncertainty (IU) explain properties of and returns to the post-earnings-announcement-drift (PEAD) trading anomaly. Consistent with a rational learning explanation, we find that: (1) unexpected earnings (UE) signals that are characterized as having greater IU have more muted initial market reactions; (2) extreme UE portfolios are characterized by securities with higher IU than non-extreme UE portfolios; and (3) within the extreme UE portfolios, high IU securities are more prevalent and earn larger abnormal returns than low IU securities. Further tests show that prior evidence of greater PEAD profitability for higher idiosyncratic volatility securities is explained by the greater information uncertainty associated with these securities.

Frazzini, Andrea.  The Disposition Effect and Underreaction to News. Journal of Finance: 2006.

This paper tests whether the “disposition effect,” that is the tendency of investors to ride losses and realize gains, induces “underreaction” to news, leading to return predictability. I use data on mutual fund holdings to construct a new measure of reference purchasing prices for individual stocks, and I show that post-announcement price drift is most severe whenever capital gains and the news event have the same sign. The magnitude of the drift depends on the capital gains (losses) experienced by the stock holders on the event date. An event-driven strategy based on this effect yields monthly alphas of over 200 basis points.

Garfinkel, J. and J. Sokobin. 2006. Volume, Opinion Divergence, and Returns: A Study of Post-Earnings Announcement Drift. Journal of Accounting Research 44 (1): 85-112.

This paper examines the relationship between post–earnings announcement returns and different measures of volume at the earnings date. We find that post-event returns are strictly increasing in the component of volume that is unexplained by prior trading activity. We interpret unexplained volume as an indicator of opinion divergence among investors and conclude that post event returns are increasing in ex ante opinion divergence. Our evidence is consistent with Varian [1985], who suggests that opinion divergence may be treated as an additional risk factor affecting asset prices.

Griffin, J. M., T. Shu, and S. Topaloglu. 2008. How Informed are the Smart Guys? Working Paper.

We examine the information content of trading by examining institutional investors’ ability to trade in the correct direction in the days immediately preceding large value-relevant events. Prior to takeovers, institutional investors are actually small (insignificant) net sellers and there is no evidence that their trading can predict takeover premiums. Institutional trading in the five and ten days prior to earnings announcements is uninformative of earnings announcement returns. For large positive and negative price moves other than takeovers and earnings announcements, we find institutional selling ahead of large up-moves, and institutional buying ahead of large negative returns. We further examine short-term institutional net buying unconditionally and find that it is uninformative of future one- and two-week stock returns. In contrast, we find that institutional trading on and after earnings announcements is profitable. Overall, our findings suggest that aggregate institutional profits may primarily stem from their ability to process publicly available information rather than their ability to extract private information.

Hirshleifer, D., J. Myers, L. Myers, and S. Teoh, 2008. Do individual investors drive post-earnings announcement drift? Working paper, Ohio State University.

This study tests whether naïve 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.

Hirshleifer, D., S. Lim, and S. Teoh. 2009. Driven to Distraction: Extraneous Events and Underreaction to Earnings News. Journal of Finance forthcoming.

Recent studies propose that limited investor attention causes market underreactions. This paper directly tests this explanation by measuring the information load faced by investors. The investor distraction hypothesis holds that extraneous news inhibits market reactions to relevant news. We find that the immediate price and volume reaction to a firm’s earnings surprise is much weaker, and post-announcement drift much stronger, when a greater number of same-day earnings announcements are made by other firms. We evaluate the economic importance of distraction effects through a trading strategy, which yields substantial alphas. Industry-unrelated news and large earnings surprises have a stronger distracting effect.

Hribar, P., Jenkins, N.T., Johnson, W.B. (2005) Stock repurchases as an earnings management device. Journal of Accounting and Economics.

We hot gay porn investigate whether firms use stock repurchases to meet or beat analysts’ earnings per share (EPS) forecasts. We identify conditions under which repurchases increase EPS and document the frequency of accretive repurchases from 1988 to 2001. We find a disproportionately large number of accretive stock repurchases among firms that would have missed analysts’ forecasts without the repurchase. The repurchase-induced component of earnings surprises appears to be discounted by the market, and this discount is larger when the repurchase seems motivated by EPS management, although using the repurchase to avoid missing analyst forecasts appears to mitigate some of the negative stock price response.

Hughes, John S., Liu, Jing and Su, Wei, On the Relation between Predictable Market Returns and Predictable Analyst Forecast Errors (September 2006). Available at SSRN:

This anime hentai porn paper tests the underreaction explanation and risk-based explanation for the Post-Earnings-Announcement Drift (PEAD) anomaly. We first show that analyst forecast errors are predictable by prior stock returns, beyond what has been previously shown. We then decompose the forecast errors into an expected component and a shock component. The underreaction explanation asserts that the PEAD is a result of underreaction to the shock component, while the risk-based explanation implies that the PEAD contains two possible separate sources, reflecting a positive covariance between expected returns and each of the two components of the forecast error. We find that the predictable component of the forecast error accounts for 35% of the PEAD returns on average, and almost 100% for firms in the top quintile of market capitalization. These results suggest that the outperformance of PEAD strategies could manifest a risk-return relation.

Jegadeesh, N., Livnat, J. (2006). Post-Earnings-Announcement Drift: The Role of Revenue Surprises. Financial Analysts Journal.

The study reported here consisted of estimating earnings and sales (or revenue) surprises either with historical time-series data or with analyst forecasts. Post-earnings-announcement drift was found to be stronger when the revenue surprise was in the same direction as the earnings surprise. This result proved to be robust to various controls, including the proportions of stock held by institutional investors, arbitrage risk, and turnover (prior 60-month average trading volume). This finding is consistent with prior evidence that earnings surprises have a more persistent effect on future earnings growth when they consist of higher revenue surprises than when they consist of lower expense surprises.

Jegadeesh, R. and J. Livnat. 2006. Revenue surprises and stock returns. Journal of Accounting and Economics 41: 147-171.

This paper examines the relation between revenue surprises and contemporaneous and future stock returns. It also investigates whether analysts update their earnings forecasts in response to revenue surprises in a timely and unbiased fashion. Stock price reaction on the earnings announcement date is significantly related to contemporaneous as well as past revenue surprises. After controlling for earnings surprises, we find significant abnormal returns in the post-announcement period for stocks that have large revenue surprises. Although analysts revise their forecasts of future earnings in response to revenue surprises, they are slow to incorporate fully the information in revenue surprises.

Ke, B., and S. Ramalingegowda. 2005. Do institutional investors exploit the post-earnings announcement drift? Journal of Accounting and Economics 39: 25-53.

We hentai porn pics provide evidence that transient institutional investors (i.e., those actively trading to maximize short term profits) trade to exploit the post-earnings announcement drift (PEAD). We estimate that transient institutions’ arbitrage generates an abnormal return of 5.1% (or 22% annualized) after transaction costs. In addition, their arbitrage trades accelerate the speed that stock prices reflect the implications of current earnings for future earnings. However, transient institutions trade less aggressively to exploit PEAD in firms with high transaction costs. Our results contribute to understanding the role of transient institutional investors in explaining the persistence of PEAD.

Kimbrough, M. 2005. The effect of conference calls on analyst and market underreaction to earnings announcements. The Accounting Review 80, 189-219.

I extend prior research on the information content of conference calls by examining whether they accelerate analysts’ and investors’ responses to the future implications of currently announced earnings. I find that the initiation of conference calls is associated with a significant reduction in the serial correlation in analyst forecast errors, a measure of initial analyst underreaction. I also find that the initiation of conference calls is associated with significant reductions in two measures of initial investor underreaction: (1) post-earnings announcement drift and (2) the proportion of the total market reaction to firms’ earnings announcements that is “delayed” (i.e., that is attributable to post-earnings announcement drift). The reduction in post-earnings announcement drift surrounding conference call initiation is concentrated in the set of sample firms where drift is most severe (i.e., the smallest, least heavily traded sample firms) while the largest, most heavily traded sample firms do not exhibit significant drift either before or after conference call initiation. Robustness tests, including analyses of matched samples of nonconference call firms, indicate that the results are not driven by general increases in analyst and investor sophistication over time or by contemporaneous increases in the information and trading environments of conference call initiators.

Kinney, William; Burgstahler, David; and Martin, Roger, 2002, Earnings Surprise “Materiality” as Measured by Stock Returns, Journal of Accounting Research, Vol. 40, No. 5, pp. 1297-1329.

Ranked earnings surprise portfolios formed from First Call files for 1992-97 are used to assess the annual earnings surprise magnitude for an individual firm sufficient to expect a “significant market reaction.” We find that, for an individual firm, the maximum probability of a gain from trading on prior knowledge of any surprise magnitude is .622. The lack of probable trading gains is due to the S-shaped surprise/return relation and the large variance of returns for a given magnitude of surprise. In turn, we find that the S-shape is related empirically to the dispersion of analyst forecasts. Thus, factors underlying dispersion differences are related to the importance or “materiality” of earnings surprise as measured by stock returns and explain at least part of the S-shaped surprise/return relation.

Lambert, R. A. 2004. Discussion of ‘Analysts’ treatment of non-recurring items in Street earnings’ and ‘Loss function assumptions in rational expectations tests on financial analysts’ earnings forecasts’. Journal of Accounting and Economics 38 (1-3): 205-222.

This article discusses papers by Gu and Chen, “Analysts’ Treatment of Non-recurring Items In Street Earnings” and by Basu and Markov, “Loss Function Assumptions in Rational Expectations Tests on Financial Analysts’ Earnings Forecasts.” These two papers address issues associated with the rationality or expertise of analysts, and both papers interpret their evidence as supporting the hypothesis that analysts do a good job of processing information and forecasting earnings, results that contrast with a growing literature that is critical of the incentives and abilities of analysts. My article critiques their methods and conclusions, and suggests areas for future research.

Latane, H. and C. Jones. 1977. Standardized Unexpected Earnings-A Progress Report. Journal of Finance 32 (5): 1457-1465.

Abstract unavailable

Lerman, A., J. Livnat, and R. R. Mendenhall. 2007. Double Surprise into Higher Future Returns. Financial Analysts Journal 63 (4): 63-71.

Post-earnings-announcement drift is the well-documented ability of earnings surprises to predict future stock returns. Despite nearly four decades of research, little has been written about the importance of how earnings surprise is actually measured. We compare the magnitude of the drift when historical time-series data are used to estimate earnings surprise with the magnitude when analyst forecasts are used. We show that the drift is significantly larger when analyst forecasts are used. Furthermore, we show that using the two models together does a better job of predicting future stock returns than using either model alone.

Lerman, A., J. Livnat, and R. R. Mendenhall. 2008. The High-Volume Return Premium and Post-Earnings Announcement Drift. Working Paper.

This paper investigates the relationship among trading volume around earnings announcements, earnings forecast errors, and subsequent returns. Prior research finds a positive relation between earnings announcement period trading volume and subsequent returns (the high-volume return premium) and between earnings forecast errors and subsequent returns (post-earnings announcement drift). We find that for a sample of firms followed by analysts these effects are complementary, i.e., each retains incremental ability to predict post-earnings announcement returns. Prior research provides two competing explanations for the high-volume return premium: changes in firm visibility versus differences in risk. We provide evidence that seems to rule out risk-based explanations while supporting the visibility hypothesis.

Lerman, A., Livnat, J., Mendenhall, R.R. (2007). Double Surprise into Higher Future Returns. Financial Analysts Journal.

Post-earnings-announcement drift is the well-documented ability of earnings surprises to predict future stock returns. Despite nearly four decades of research, little has been written about the importance of how earnings surprise is actually measured. We compare the magnitude of the drift when historical time-series data are used to estimate earnings surprise with the magnitude when analyst forecasts are used. We show that the drift is significantly larger when analyst forecasts are used. Furthermore, we show that using the two models together does a better job of predicting future stock returns than using either model alone.

Liang, L., 2003. Post-earnings-announcement-drift and market participants. information processing biases. Review of Accounting Studies, 321-345.

Prior research has been unable to explain the phenomenon known as post-earnings announcement drift, raising questions concerning the semi-strong form efficiency of the market typically assumed in capital market research. This study contributes to our understanding of this anomaly by examining drift in the context of theories that consider investors’ non-Bayesian behaviors. The empirical evidence reveals that investors’ overconfidence about their private information and the reliability of the earnings information are two important factors that explain drift. Finally, this study also provides insight into the puzzling relationship between dispersion and drift discussed in prior research.

Libby, nolvadex online R., Tan, H.T., Hunton, J.E. (2006). Does the Form of Management’s Earnings Guidance Affect Analysts’ Earnings Forecasts? The Accounting Review.

This study examines how the form of managements’ earnings guidance (point, narrow range, wide range) affects analysts’ earnings forecasts. Results from two experiments demonstrate that: (1) guidance form has no effect on analysts’ forecasts made immediately after the guidance; and (2) after the actual earnings announcement, guidance form and the relationship of the earnings guidance to actual earnings (guidance error) interact in their effect on analysts’ forecasts. After the actual earnings announcement, guidance error leads to higher (lower) analysts’ forecasts for firms with downwardly (upwardly) biased guidance; this effect of guidance error is magnified by a narrow range and reduced by a wide range, compared to a point estimate. These results suggest that treating the mean of the range endpoints as equivalent to a point estimate and failing to consider effects after the release of actual earnings may paint an incomplete picture of how management guidance affects analysts and investors. It also offers useful information to managers who issue earnings guidance, and presents a challenge to the psychology literature regarding the effects of information precision on judgment and decision making.

Liu, W., N. Strong, and X. Xu (2003). Post-earnings-announcement drift in the UK. European Financial Management 9, 89-116.

This paper fills a void in the market efficiency literature by testing for the presence of post–earnings–announcement drift in a non–US market. We test for drift using alternative earnings surprise measures based on: (i) the time–series of earnings; (ii) market prices; and (iii) analyst forecasts. Using each of the measures we find evidence of significant post–earnings–announcement drift, robust to alternative controls for risk and market microstructure effects. Using a one–dimensional analysis, the price–based measure of earnings surprise gives the strongest drift, and using a two–dimensional analysis the drift associated with the price–based measure almost subsumes drift associated with the other two measures. Our conclusion is that the UK stock market is inefficient with respect to publicly available corporate earnings information. This evidence provides out–of–sample confirmation of the post–earnings–announcement drift documented in the USA.

Livnat, J. and R. R. Mendenhall. 2006. Comparing the post-earnings announcement drift for surprises calculated from analyst and time series forecasts. Journal of Accounting Research 44 (1): 177-205.

Post–earnings announcement drift is the tendency for a stock’s cumulative abnormal returns to drift in the direction of an earnings surprise for several weeks following an earnings announcement. We show that the drift is significantly larger when defining the earnings surprise using analysts’ forecasts and actual earnings from I/B/E/S than when using a time series model based on Compustat earnings data. Neither Compustat’s policy of restating earnings nor the inclusion of “special items” in reported earnings contribute significantly to the disparity in drift magnitudes. Rather, our results suggest that this disparity is attributable to differences between analyst forecasts and those of time-series models—or at least to factors correlated with these differences. Further, we document that analyst forecasts lead to return patterns around future earnings announcements that differ from those observed when using time-series models, suggesting that the two types of surprises may capture somewhat different forms of mispricing.

Livnat, Joshua and Petrovits, Christine, 2009, Investor Sentiment, Post-Earnings Announcement Drift, and Accruals, AAA 2009 Financial Accounting and Reporting Section (FARS) Paper, Available at SSRN:

There celebrity nude is growing evidence in the finance literature that investor sentiment affects stock prices. We examine whether stock price reactions to earnings surprises and accruals vary systematically with the level of investor sentiment. Using quarterly drift tests and monthly trading strategy (calendar time) tests, we find evidence that holding extreme good news firms following pessimistic sentiment periods earns significantly higher abnormal returns than holding extreme good news firms following optimistic sentiment periods. Similarly, our results suggest that holding low accrual firms following pessimistic sentiment periods earns significantly higher abnormal returns than holding low accrual firms following optimistic sentiment periods. We also document that abnormal returns in the short-window around preliminary earnings announcements for extreme good news firms are significantly higher during periods of low sentiment than during periods of high sentiment. Overall, our results indicate that investor sentiment influences the source of excess returns from earnings-based trading strategies.

Livnat. (2003). Post-Earnings-Announcement Drift: The Role of Revenue Surprises and Earnings Persistence.

This study explores an additional factor that is associated with differential levels of the post-earnings-announcement drift (henceforth drift) the contemporaneous surprise in revenues. Consistent with prior evidence about greater persistence of revenues and greater noise caused by heterogeneity of expenses, this study shows that the earnings drift is stronger when the revenue surprise is in the same direction as the earnings surprise. Moreover, the study provides direct evidence that the drift is stronger when the earnings persistence is greater. The results are robust to various controls, including the proportions of stock held by institutional investors, trading liquidity, and arbitrage risk.

2006 Version with Jegadeesh

The study reported here consisted of estimating earnings and sales (or revenue) surprises either with historical time-series data or with analyst forecasts. Post-earnings-announcement drift was found to be stronger when the revenue surprise was in the same direction as the earnings surprise. This result proved to be robust to various controls, including the proportions of stock held by institutional investors, arbitrage risk, and turnover (prior 60-month average trading volume). This finding is consistent with prior evidence that earnings surprises have a more persistent effect on future earnings growth when they consist of higher revenue surprises than when they consist of lower expense surprises.

Maines, L. A. and J. R. M. Hand.  1996. Individuals’ perceptions and misperceptions of the time series properties of quarterly earnings. The Accounting Review 71 (3): 317-336.

This study uses experiments to examine whether individuals’ earnings forecasts correctly reflect the time series properties of quarterly earnings, in particular, the positive autocorrelation in seasonal quarterly changes and the negative fourth-order moving average term documented by Brown and Rozeff (1979). We find that individuals’ forecasts are sensitive to the magnitude of these time series components; however, individuals typically underweight the moving average term and under- (over-)weight the most recent seasonal quarterly change when it has a strong (weak) effect on future earnings. Individuals also place slightly more weight on quarterly changes when earnings are reported relative to those four quarters prior. These results suggest that the documented stock market under-reaction to quarterly earnings may not hold universally; rather, it may be composed of under-reactions to firms with strong autocorrelation in seasonal changes and over-reactions to firms with weak autocorrelation in seasonal changes.

McDonald, Bill and Mendenhall, Richard R., 2009, Implementing the Earnings Surprise Strategy, Available at SSRN:

We study the profitability of a strategy based on the earnings surprises. First, we attempt to identify variables, in addition to earnings surprise, that will improve our ability to predict post-earnings announcement returns. Second, we test a strategy based on the SUE effect using a stock-market simulation that considers transactions costs, short-sales constraints, and cash management issues, e.g., is cash available when a buy transaction is called for by the strategy? Discussions with practitioners indicate that the assumptions behind our simulation are fairly realistic. Our results, unfortunately, are inconclusive. While the SUE strategy earned significantly higher returns over the 1988 through 1992 time period than a buy-and-hold strategy, the superior performance was confined almost entirely to a two-year sub-period. That we can devise a simple strategy, however, with a turnover in excess of 300% per year that can perform as well as the value-weighted index over three years of the study and outperform it by a very wide margin for two years, suggests that money managers might formulate more sophisticated strategies that can do even better.

Mendenhall, R. 2004. Arbitrage risk and post-earnings-announcement drift. Journal of Business 77 (4): 875-894.

This study examines whether the magnitude of post‐earnings‐announcement drift is related to the risk faced by arbitrageurs, who may view the anomaly as a trading opportunity. Consistent with this hypothesis, the magnitude of the drift is strongly related to the arbitrage risk measure developed by Wurgler and Zhuravskaya (2002). The effect of arbitrage risk is statistically and economically significant in a range of specifications. The results support the view of post‐earnings‐announcement drift as an underreaction to earnings information.

Narayanamoorthy, G., 2006. Conservatism and cross-sectional variation in the post-earnings announcement drift. Journal of Accounting Research 44, 763–789.

Accounting conservatism allows me to identify a previously undocumented source of predictable cross-sectional variation in Standardized Unexpected Earnings’ autocorrelations viz. the sign of the most recent earnings realization and present evidence that the market ignores this variation (“loss effect”). It is possible to earn returns higher than from the Bernard and Thomas (1990) strategy by incorporating this feature. Additionally, the paper shows that the “loss effect” is different from the “cross quarter” effect shown by Rangan and Sloan (1998) and it is possible to combine the two effects to earn returns higher than either strategy alone. Thus, the paper corroborates the Bernard and Thomas finding that stock prices fail to reflect the extent to which quarterly earnings series differ from a seasonal random walk and extends it by showing that the market systematically underestimates time-series properties resulting from accounting conservatism.

Ng, Gay Porn J., T. Rusticus, and R. Verdi. 2008. Implications of transaction costs for the post-earnings-announcement drift. Journal of Accounting Research 46 (3): 661-696.

This paper examines the effect of transaction costs on the post–earnings announcement drift (PEAD). Using standard market microstructure features we show that transaction costs constrain the informed trades that are necessary to incorporate earnings information into price. This implies weaker return responses at the time of the earnings announcement and higher subsequent returns drift for firms with higher transaction costs. Consistent with this prediction, we find that earnings response coefficients are lower for firms with higher transaction costs. Using portfolio analyses, we find that the profits of implementing the PEAD trading strategy are significantly reduced by transaction costs. In addition, we show, using a combination of portfolio and regression analyses, that firms with higher transaction costs are the ones that provide the higher abnormal returns for the PEAD strategy. Our results indicate that transaction costs can provide an explanation not only for the persistence but also for the existence of PEAD.

Odean, T. 1999. Do investors trade too much? American Economic Review 89: 1279-1289.

Abstract unavailable

Reed, A., 2007, Costly short-selling and stock price adjustments to earnings announcements, Working paper, University of North Carolina

We study the effect of short sale constraints on the informational efficiency of stock prices using a direct measure of shot sale constraints. Specifically, we test the Diamond and Verrecchia (1987) hypothesis that short sale constraints reduce the speed at which prices adjust to private information. We show that stocks for which short selling is costly have larger price reactions to earnings announcements, especially to bad news. We confirm the Diamond and Verrechia (1987) prediction that the distribution of announcement day returns is more left skewed and returns have larger absolute values when short selling is constrained. We find that trading volume falls and prices become less informative when short selling is constrained. Furthermore, the fraction of long run price reaction realized on the day of the announcement is smaller when short selling is constrained.

Rees, L. (U Houston), Shiva Sivaramakrishnan (U Houston)   The Effect of Meeting or Beating Revenue Forecasts on the Association Between Quarterly Returns and Earnings Forecast Errors – 2004

Abstract unavailable

Richardson, S., I. Tuna, and P. Wysocki. 2010. Accounting anomalies and fundamental analysis: A review of recent research advances. Journal of Accounting and Economics 50: 410-454.

We survey recent research in accounting anomalies and fundamental analysis. We use forecasting of future earnings and returns as our organizing framework and suggest a roadmap for research aiming to document the forecasting benefits of accounting information. We combine this with opinions from the academic and practitioner communities to critically evaluate key clusters of papers about accounting anomalies and fundamental analysis disseminated over the last decade. Finally, we provide a new analysis on how an ex ante and ex post treatment of risk and transaction costs affects the accrual and PEAD anomalies, and offer suggestions for future research.

Richardson, S., S. H. Teoh, and P. D. Wysocki. 2004. The walk-down to beatable analyst forecasts: The role of equity issuance and insider trading incentives. Contemporary Accounting Research 21 (4): 885-924.

It animated porn has been alleged that firms and analysts engage in an “earnings-guidance game” where analysts first issue optimistic earnings forecasts and then “walk down” their estimates to a level that firms can beat at the official earnings announcement. We examine whether the walk-down to beatable targets is associated with managerial incentives to sell stock after earnings announcements on the firm’s behalf (through new equity issuance) or from their personal accounts (through option exercises and stock sales). Consistent with these hypotheses, we find that the walk-down to beatable targets is most pronounced when firms or insiders are net sellers of stock after an earnings announcement. These findings provide new insights on the impact of capital-market incentives on communications between managers and analysts.

Sadka, R. 2006. Momentum and post-earnings-announcement drift anomalies: The role of liquidity risk. Journal of Financial Economics 80: 309-349.

This paper investigates the components of liquidity risk that are important for understanding asset-pricing anomalies. Firm-level liquidity is decomposed into variable and fixed price effects and estimated using intraday data for the period 1983–2001. Unexpected systematic (market-wide) variations of the variable component rather than the fixed component of liquidity are shown to be priced within the context of momentum and post-earnings-announcement drift (PEAD) portfolio returns. As the variable component is typically associated with private information [e.g., Kyle, 1985. Econometrica 53, 1315–1335], the results suggest that a substantial part of momentum and PEAD returns can be viewed as compensation for the unexpected variations in the aggregate ratio of informed traders to noise traders.

Shanthikumar, D., 2004. Small and large trades around earnings announcements: Does trading behavior explain post-earnings announcement drift? Working paper, Harvard Business School.

This paper analyzes trade-initiation by small and large traders for one year following earnings announcements and examines the predictive ability of event-time trading for future returns. With earnings surprises based on a seasonal random walk expectations model, small traders react slightly more weakly than large traders, during the event window, to the first surprise in a series of similar surprises, but more strongly than large traders to the later surprises. With earnings surprises based on analyst forecasts, small traders react more weakly than large traders regardless of the past series. Large traders trade in the direction of the earnings surprise for one month after the earnings announcement, while small traders do not. Starting in month two this switches and small traders trade in the direction of the surprise, while large traders do not. The strength of the small trade event-time reaction is a weak positive predictor of returns in the first month after the announcement and a weak negative predictor of drift after the first month. Large trade reaction is generally a negative predictor of future drift. The collection of evidence points to both small and large trader underreaction to earnings announcements, with small trader underreaction more severe in the first month. In month one, large traders capitalize on drift, but after that small traders seem to correct and possibly overreact.

Shivakumar, L. 2006. Accruals, cash flows and the post-earnings-announcement drift. Journal of Business Finance & Accounting 33, 1-25.

Several prior studies have shown that cash flows have significantly greater impact on stock prices than accruals. We examine the implications of these findings for the post-earnings-announcement-drift anomaly. We argue that, if investors under-react to earnings news, then the larger price impact of cash flows causes the cash flow component of earnings news to predict future returns better than the accruals component. Consistent with this argument, we show that unexpected cash flows are more positively related to future returns, than are unexpected accruals. Also, unexpected cash flows are found to predict future returns above and beyond that predicted by earnings surprises. Finally, we show that a strategy that decomposes earnings news into its components significantly outperforms strategies based on earnings news alone. The results support under-reaction explanations for the drift.

Skinner, D., and Sloan, R. G., 2002, Earnings surprises, growth expectations, and stock returns or don’t let an earnings torpedo sink your portfolio, Review of Accounting Studies 7 (2–3), pp. 287–312.

We provide new evidence that the inferior returns to growth stocks relative to value stocks are the result of expectational errors about future earnings performance. Our evidence demonstrates that growth stocks exhibit an asymmetric response to earnings surprises. We show that while growth stocks are at least as likely to announce negative earnings surprises as positive earnings surprises, they exhibit an asymmetrically large negative price response to negative earnings surprises. After controlling for this asymmetric price response, we find no remaining evidence of a return differential between growth and value stocks. We conclude that the inferior return to growth stocks is attributable to overoptimistic expectational errors that are corrected through subsequent negative earnings surprises.

Sloan, R. 1996. Do stock prices fully reflect information in accruals and cash flows about future earnings? The Accounting Review 71: 289-315.

This latest celebrity news paper investigates whether stock prices reflect information about future earnings contained in the accrual and cash flow components of current earnings. The extent to which current earnings performance persists into the future is shown to depend on the relative magnitudes of the cash and accrual components of current earnings. However, stock prices are found to act as if investors “fixate” on earnings, failing to reflect fully information contained in the accrual and cash flow components of current earnings until that information impacts future earnings.

Taylor, D. 2010a. Retail investors and the adjustment of stock prices to earnings information. Working paper

This study examines the effect of contrarian retail trades on the pricing of earnings information. Consistent with price pressure from contrarian retail trades delaying the adjustment of prices to earnings information, we find that the negative price drift accompanying bad news is largest when retail investors buy on bad news, and that the positive price drift accompanying good news is largest when retail investors sell on good news. These findings are consistent with the correlated trading of retail investors around earnings announcements causing a delayed price adjustment which manifests as drift.

Taylor, D. 2010b. Individual investors and corporate earnings. Working Paper.

This study examines the effect of earnings announcements on individual investors’ trading decisions and their trading profits. Consistent with earnings news informing the trading decisions of individual investors, I find that earnings announcements are associated with significant increases in individual investor market participation, and that these increases persist even after controlling for the information in prices. Moreover, and in contrast to the conventional wisdom that disclosure benefits unsophisticated investors at the expense of more sophisticated investors, I find that individuals’ trades around earnings announcements earn economically and statistically significant losses, and that these losses are significantly greater than the losses of non-announcement trades. Consistent with these losses resulting from inefficient information processing, I find the higher the information content of the earnings announcement the greater the loss, and that increased losses around earnings announcements are concentrated among those individual investors who are not classified as affluent or active traders. Given the limited information processing ability of individual investors, the results suggest a more nuanced view of the welfare effects of disclosure.

Varian, H. 1985. Divergence of opinion in complete markets: A note. Journal of Finance 40: 309-17.

We hot gay porn consider an Arrow-Debreu model with agents who have different subjective probabilities. In general, asset prices will depend only on aggregate consumption and the distribution of subjective probabilities in each state of nature. If all agents have identical preferences then an asset with “more dispersed” subjective probabilities will have a lower price than an asset with less dispersed subjective probabilities if risk aversion does not decline too rapidly. It seems that this condition is likely to be met in practice, so that increased dispersion of beliefs will generally be associated with reduced asset prices in a given Arrow-Debreu equilibrium.

Vega, C. 2006. Stock price reaction to public and private information. Journal of Financial Economics 82: 103-133.

I use Easley and O’Hara’s [1992, Journal of Finance 47, 577–604] private information-based trading variable, PIN, together with a comprehensive public news database to empirically measure the effect of private and public information on the post-announcement drift. I show that stocks associated with high PIN, consensus public news surprises, and low media coverage experience low or insignificant drift. Thus not all information acquisition variables have the same effect on the market’s efficiency. Whether information is public or private is irrelevant; what matters is whether information is associated with the arrival rate of informed or uninformed traders.

Williams (U Baltimore), Dadalt (U RI),  H Sun(Morgan State), Yaari (Morgan State) –  Has Regulation Changed the Market’s Reward for Meeting or Beating Expectations ?  – Focus on Finance and Accounting Research

A firm meets or beats expectations when it reports earnings that are at or above the consensus analysts’ forecast. We argue that two types of firms MBE: strong firms who commit to future performance and signal future earnings by MBE, and weak firms who attempt to mimic strong firms by managing either expectations or earnings. Using a sample of 4,152 earnings announcements for firms that habitually MBE between 1999 and 2004, we find that the incidence of expectations (earnings) management decreased following the enactment of Regulation FD (Sarbanes Oxley). In addition, we find that the market reactions to MBE achieved through managing expectations declined significantly following the enactment of Regulation FD, but not to MBE achieved by managing earnings following the enactment of the Sarbanes-Oxley Act.

Z Yan (Brandeis), Y Zhao (Brandeis) A New Measure of Earnings Surprise sand Post Earnings announcement Dirtu (2006)

In this article, we develop a new measure of earnings surprises – the earnings surprise elasticity (ESE), which is defined as the absolute value of earnings announcement abnormal returns (EARs) scaled by earnings surprises (in percentage). The nominator of the ESE captures all the information released around earnings announcement dates and market reactions to the information; the denominator of the ESE gives special emphasis to the earnings surprises. We explore the ESE under four different categories in terms of the signs of earnings surprises (+/-) and the signs of EARs (+/-). We find that: a). Across all four sub-samples, larger firms have smaller earnings surprises and bigger EARs (both in absolute values), thus have higher ESE quintiles. b). Firms in the highest ESE quintile usually have much smaller post earnings announcement cumulative abnormal returns (CARs) in absolute value than firms in the lowest ESE quintile; c). Against conventional wisdom, for around 36% of total observations, the earnings surprises and EARs move in opposite directions. d). More than 11% firms have zero surprises. They are larger firms with larger institutional shareholdings and followed by more analysts. It is not wise to invest in this group of firms as evidenced in the negative post announcement CARs. e). A trading strategy of taking a long position in firms in the lowest ESE quintile when both the earnings surprises and EARs are positive and a short position in firms in the lowest ESE quintile when both are negative can generate 5.19% quarterly abnormal return.

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