Earnings Releases, Anomalies, and the Behavior of Security Returns.

Abstract

Abstract ABSTRACT: 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.