Price and Trading Volume Reaction Surrounding Earnings Announcements: A Closer Examination

Topics: Stock market, Arithmetic mean, Stock Pages: 38 (3045 words) Published: February 23, 2014
Journal of Accounting Research
Vol. 19 No. 2 Autumn 1981
Printed in U.S.A.

Price and Trading Volume Reaction
Surrounding Earnings
Announcements: A Closer
Examination
DALE MORSE*

I. Introduction
The process of information dissemination and interpretation in securities markets is very complex and mostly unobservable. While changes in prices and the amount of trading that takes place at the market level provide evidence of information processing, Verrecchia [1981] demonstrated that these are not sufficient to describe completely the dissemination of information and its interpretation hy investors. A descriptive study of price changes and trading volume, however, may still provide some insights into how investors react to information. This paper is an empirical investigation of price changes and trading volume during the days surrounding the announcement of quarterly and annual earnings in

the Wall Street Journal {WSJ).
In the original paper investigating trading volume and price changes surrounding earnings announcements. Beaver [1968] was primarily concerned with whether the annual earnings announcement had "information content" (i.e., led to changes in investors' assessments of the prohability distrihution of future returns). If there were any significant price changes and/or trading volume during the week of the announcement, then the annual earnings announcement was assumed to have had * A.ssistant Profes.sor, Cornell University. I would like to thank William Beaver, James Patell, and David Ng for special help on my dissertation from which this paper is derived. Also, I have modified this paper ba.sed on helpful comments from the Cornell Accounting Workshop and anonymous referees. Financial support from the Arthur Andersen Foundation was greatly appreciated. [Accepted for publication October 1980.) 374

Copyright ®, Institute of Professional Accounting 198]

REACTION SURROUNDING EARNINGS ANNOUNCEMENT

375

"information content," Significant price changes and trading volume were found during the announcement week. Kiger [1972] observed similar results during the three days surrounding quarterly earnings announcements. Rather than determining the existence or nonexistence of information content in accounting announcements, this paper uses daily data to examine when the market reacts relative to an earnings announcement—particularly quarterly ones—in the WSJ. Whether the market reacts before or after the announcement provides additional insights into how information is disseminated and processed. Securities on both stock exchanges and over-the-counter (OTC) markets are investigated and compared.

Price changes and trading volume in securities markets may occur in situations unrelated to information specific to a particular security. Wealth and risk preference changes as well as changes in consumption opportunities may lead to a reallocation of resources. If these events are independent of the release of firm-specific information, however, large samples should diversify the effects of such noninformation factors. Market factors, both informational and noninformational, affecting prices and trading volume in general may he removed through regression. So, although trading and price changes due to firm-specific information may not be completely isolated, there are empirical methods to mitigate against the effects of other factors.

Assuming price changes and trading volume related to firm-specific information can be isolated to some degree, we can then consider interpretations of the results. The price change and trading volume activity surrounding public announcements is analyzed in detail in Morse [1978]. To summarize the arguments, trading prior to a public announcement may occur because of differences in beliefs about the probability of different signals being emitted by the public announcement. These differences in behefs may be caused by the asymmetric distribution of the information before its...

References: BEAVER, W. "Tbe Information Content of Annual Earnings Announcements," Empirical
Research in Accounting: Selected Studies, 1968
GARMAN, M. "Market Microstructure " Journal of Financial Economics (June 1976).
GRANT, E. "Market Implications of Differential Amounts of Interim Information." Journal
of Accounting Research (Spring 1980): 255-68.
KIGER, J. "An Empirical Investigation of NYSE Volume and Price Reactions to tbe
Announcements of Quarterly Earnings." Journal of Accounting Research (Spring 1972):
"Asymmetrical Information in Securities Markets and Trading Volume." Journal
of Financial and Quantitative Analysis (December 1980).
SCHOLES, M., AND J. WILLIAMS. "Estimating Betas from Non-Syncbronous Data." Journal
of Financial Economics (December 1977): 309-28.
Accounting Research (Spring 1981): 271-83.
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