Rest in Peace Post-Earnings Announcement Drift

This paper revisits price formation following earnings announcements. In modern financial markets, stock prices fully reflect earnings surprises on the announcement date, leading to the disappearance of post-earnings announcement drifts (PEAD). For large stocks, PEAD have been non-existent since 2006 but has only disappeared recently for microcap stocks. PEAD remain a prevalent area of study in finance and accounting despite having largely disappeared. This paper concludes with a set of recommendations for researchers who conduct such studies to better assess the existence of PEAD and suggests future research avenues to examine price formation following earnings news.

The Earnings Expectations Game and the Dispersion Anomaly

This study examines the role of differences in firms’ propensity to meet earnings expectations in explaining why firms with high analyst forecast dispersion experience relatively low future stock returns. We first demonstrate that the negative relation between dispersion and returns is concentrated around earnings announcements. Next, we show that this relation disappears when we control for ex ante measures of firms’ propensity to meet earnings expectations and that the component of dispersion explained by these measures drives the return predictability of dispersion. We further demonstrate that firms with low analyst dispersion are substantially more likely to achieve positive earnings surprises and provide new evidence consistent with both expectations management and strategic forecast pessimism explaining this result. Overall, we conclude that investor mispricing of firms’ participation in the earnings-expectations game provides a viable explanation for the dispersion anomaly. Accepted by Brian Bushee, accounting.

Asymmetric information and opportunism in insider share-pledging

PurposeAmid growing attention from investors, regulators and advisory firms in recent years, this study assesses whether managers exploit private information to time share-pledge transactions and extract personal benefits while avoiding unintended market scrutiny.Design/methodology/approachWe use hand-collected pledging data for a random sample of S&P 1500 firms to examine whether private information influences insider share-pledging activity using Heckman selection and two-part hurdle models of the pledge decision. We also conduct an event study analysis of announcement returns to measure market reactions to pledging news and determine whether share-pledge disclosures affect investor risk assessments.FindingsConsistent with insiders timing pledges prior to anticipated performance declines, both the likelihood and level of pledging increase significantly with negative earnings surprises. New share-pledges precede significant decreases in abnormal returns, and public announcement of new pledging corresponds with significant negative cumulative abnormal returns. The evidence suggests that insiders exploit private information to time pledges, and that investors update risk assessments and value estimates based on information conveyed by these transactions.Practical implicationsOur findings hold important implications for governance and regulation of pledged shares, indicating that permissive reporting requirements in the US facilitate informed pledging and may undermine incentive alignment between managers and shareholders. The analysis promotes transaction-specific disclosures and transparent corporate policies for insider share-pledging.Originality/valueOurs is among the first empirical analyses of share-pledging in US firms and the first to examine the role of private information in pledging decisions. We offer novel evidence on the opportunistic use of pledged shares and provide insight to predictors of share-pledging behavior.

Does Consolidation of Variable Interest Entities Improve the Pricing of Financial Reporting in Bank Holding Companies? Evidence From FAS 166/167

The study examines whether consolidating qualified special-purpose entities (QSPEs) under Statement of Financial Accounting Standards Nos. 166 and 167 (FAS 166/167) improves the market reaction to earnings disclosures. We use a difference-in-difference design to compare the change sample, which is defined as banks that consolidate QSPEs after FAS 166/167, with the no-effect sample, which is defined as financial institutions with no QSPEs or banks that do not consolidate QSPEs after FAS 166/167. The results show that, during a short window around earnings announcements, the change sample experiences higher market reaction to earnings surprises than the no-effect sample after the implementation of FAS 166/167. We also find that the effect is more pronounced in banks that engage in securitization and in financial institutions whose securitized loans originate primarily from consumer loans rather than mortgages. Additional analysis also finds that adopting FAS 166/167 enhances the ability of earnings to predict future earnings and future cash flows in banks. The important implication of the study for regulators is that FAS 166/167 improves bank transparency.

Forecastability of Earnings Surprises

I investigate whether it is possible to profitably trade on predicted earnings surprises, forecasted using the Foster (1977) model. Unlike the extant literature, which documents a strong positive relation between actual earnings surprises and returns, I find that trading on predicted earnings surprises, generated by the Foster (1977) model, has earned a small negative, but statistically indistinguishable from zero, return. This result highlights the difficulty in forecasting earnings surprises.