The Information Content Of Earnings Announcements: New Insights From Intertemporal And Cross-sectional Behavior

William H. Beaver

Joan E. Horngren Professor (Emeritus)

Graduate School of Business, Stanford University, Stanford, CA, 94305, USA

Maureen F. McNichols

Marriner S. Eccles Professor

Graduate School of Business, Stanford University, Stanford, CA, 94305, USA

Zach Z. Wang

Assistant Professor

University of Illinois at Urbana-Champaign, Champaign, IL, 61821, USA

March 14, 2015

Abstract

This study examines the information content of quarterly earnings announcements. We first use a nonparametric approach to investigate whether quarterly earnings announcements are informative between 1971 and 2011 and find unequivocal evidence that earnings announcements convey significantly more information relative to non-announcement periods. We also find that the information content increases over time with a dramatic increase from 2001 onward, a period that includes the implementation of Sarbanes Oxley reforms and the worst economic downturn since the Great Depression. We then investigate cross-sectional variation in information content. We find that the information content of earnings announcements is positively associated with profitability, firm size and analyst coverage.

The Information Content Of Earnings Announcements: New Insights From Intertemporal And Cross-sectional Behavior – Introduction

This paper examines three questions about the information content of earnings announcements. First, how robust are the earlier findings that revisions to security prices are significant when earnings are released? Second, has the magnitude of the price response to earnings announcements increased over time? Third, does the magnitude of the price response to earnings announcements vary for firms with potentially different information environments? Specifically, does the magnitude of the price response vary with the profitability of the firm, its size, or the extent of its analyst coverage?

Beginning with Ball and Brown (1968) and Beaver (1968), a large literature has examined the information content of earnings. While the early findings in this literature document that earnings announcements have significant information content, more recent literature has explored whether and how the information content of earnings varies over time and across firms. Although the question of whether earnings announcements have information content might be viewed by some as having long been settled, a number of papers question this, including Bamber et al. (2000), Ball and Shivakumar (2008), and Ball (2013). Furthermore, there are many reasons to hypothesize changes to the information content of earnings, including changes in financial reporting standards and regulation over time, changes in firms’ business models that are potentially less well captured by the current accounting model, and changes to the institutions and incentives for private production and dissemination of information. The latter includes dramatic changes in information technology that have led to significant reduction in costs of providing and disseminating information, and an increase in the availability of information throughout the year on a continuous basis. These factors potentially would serve to reduce the incremental information content of earnings announcements. The passing of time allows us to revisit this literature with a longer and potentially more varied sample period, to examine the robustness of the earlier findings and to assess whether and how the information content of earnings announcements has changed.

Three measures of the information content of earnings announcements are predominantly employed in the literature, the earnings response coefficient (ERC), for which Ball and Brown (1968) is a precursor, a measure of abnormal volume, and a measure of abnormal return volatility based on the U-statistic introduced by Beaver (1968). This study examines the information content of earnings announcements based on the abnormal return volatility measure, and therefore focuses on the information conveyed to investors at earnings announcements. We develop a U-statistic motivated by Beaver (1968), Patell (1976), and Landsman and Maydew (2002), which we refer to as TCU, for three-day cumulative U-statistic.

First, we examine whether the information released at earnings announcement days is greater than the information released at other times during our sample period. Using a distribution-free test, we find unequivocal evidence that earnings announcements convey more information to the markets than the information conveyed in non-earnings announcement periods. Specifically, we find that the mean U-statistic observed at earnings announcement periods is substantially above the 99th percentile of the distribution of U-statistics drawn from non-earnings announcement periods for each of the 41 years in our 1971 to 2011 sample period. Our statistic measuring relative price revision activity in earnings announcement periods from 1971 to 2011 is 2.54, compared to a mean of 1.18 in non-earnings announcement periods and 1.67 for the sample in Beaver (1968).

Earnings Announcements

Earnings Announcements

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