The Information Content of

Annual Earning Announcements

William H. BeaverJournal of Accounting Research (1968)

Contents

1. Motivation

2. Research Question and Conclusion

3. Sample and Data

4. Empirical Test

5. Empirical Result

6. Contribution and Suggestion

7. Expansion of Research

Motivation

Valuation the-orya relationship

between

earnings and the

value of

common stock

Miller and Modigliani(1954-57)• the value of common stock = f(earning x earnings multiplier for that risk class, …)• Empirical evidence: If reported earnings are adjusted for measurement errors

through the use of instrumental variables, the adjusted earnings are useful in the

prediction of the market value of electric utility firms

The earnings term is the most important explanatory variable in valuation equa-tion

Earnings lack

informational

value

• Measurement errors in earnings are so large• Other sources available to investors that contain essentially the same information

but are more timely

Earnings reports have little or no information content

MotivationTo provide empirical evidence to ascertain whether accounting numbers contained or conveyed information about a firm’s financial performance

Section 1. Motivation

2/13

Research Question and Conclusion

Does common stock investors perceive earnings to

possess informational value ?

A firm’s earnings report is informative (Information content)

• If it leads to a change in investors’ assessments of the

probability distribution of future returns (or price)

Change in equilibrium value of the market price

Change in expectations

about the outcome of an

event

Definition. of Information

Sufficiently large change

to induce a change

in the decision-maker’s be-havior

• If it leads to an altering of the optimal holding of that firm’s

stock in the portfolios of individual investors

Shift in portfolio position would be reflected in the volume

Section 2. Research Question and Conclusion

3/13

Expectations of individual investors and the market as a whole are altered by the earnings report Earnings reports possess information content

Primary Research method

Earnings announcement

Different interpretation

among investors

Lack of consen-sus regarding the price

Increasing vol-ume before a con-sensus is reached

Change in equilibrium value

Changes in the

expectations of the

market as a whole

Price test

Changes in the

expectations of

individual investors

Volume test

4/13

Analyze investor reaction to earnings announcement,

as reflected in the “ volume” and “price” movements of com-

mon stocks in the weeks surrounding the announcement date

Section 2. Research Ques-tion

If risk preferences

differ, volume reaction

Sample and Data

Sample and Data Collection

1. Firm on Compustat tape

2. New York Stock Exchange firms

3. Non-12/31 firms

4. No dividend announcement in the same week as the

earning announcements

5. No stock splits announcement during the 17

week period surrounding the earning an-

nouncements

6. Less than 20 news announcements per

year appearing in the WSJ• 143 firms

• 506 annual earnings announcements

• Sample period: 1961~1965

Section 3. Sample and Data

5/13

Volume Analysis-Unadjusted for Market Influence

Analysis method

Vjt = Computed for each week t in the report period for each of the 506 earning announcement j

Earnings reports have information content

Hypothesis

If earning reports convey information in the

sense of leading to changes in the optimal portfolio

positions, the number of shares traded should be

higher in week 0 than during nonreport period.

Section 4. Empirical Test

6/13

Results

Volume Analysis-Adjusted for Market Influence

Results

Earnings reports have information content

Nonreport

period

Hypothesis

If earning reports convey information in the

sense of leading to changes in the optimal portfolio

positions, the number of shares traded should be

higher in week 0 than during nonreport period.

Analysis method

Report

period

Section 4. Empirical Test

7/13

Price Analysis-Adjusted for Market Influence

HypothesisIf earning reports convey information in the sense of leading to changes in the equilibrium

value of the current market price, the magnitude of the price change(without respect to

sign) should be larger in week 0 than during nonreport period.

Analysis method

uit = portion of the individual security’sfirm-specific price change

Nonreport

periodu2 it = the square of residual (to elimi-

nate the effect of the signal of residual)

itsi2 = mean of u2 during the nonreport

itperiod (= Var(u2 ))

Report

period

Section 4. Empirical Test

8/13

Price Analysis-Adjusted for Market Influence, continued

Results

Earnings reports have information content

Section 4. Empirical Test

9/13

Empirical Result

The largest change in price in

the announcement week

The largest increase in volume

in the announcement week

Analysis

1

Volume(unadjusted)

2

Volume

(adjusted)

3

Price(adjusted)

Not only are expectations of

individual investors altered by

earnings report,

But also the expectations of the

market as a whole.

Empirical Results

10/13

The information contents of annual earnings announcements

Section 5. Empirical Re-sult

Relationship between the Volume and the Price Findings

Section 5. Empirical Re-sult

The issue “How much of the increase price activity can be attributed merely to the fact that there is more “action” in the security, rather than to changes in equilibrium prices?”

Price changes = sum of price

changes on each transaction

1

• The variance of the weekly price change will

increase in direct to proportion to the number

of transactions that occur during the time

period

Changes in_price

activity (Ut)

= 1.67

More action (et ) = 1.3_

Changes in equilibrium

prices = 0.37

The expectations of the all investors influence

the market price, whether or not they engage in

a purchase or a sale

2

• The total number of transactions, explicit

and implicit, are the same per time period

Changes

in_price activity

(Ut)

= 1.67

More action (et ) = 0

Changes in equilibrium

prices = 1.67

_

11/13

Additional empirical research is needed before this issue will be resolved.

Contribution

Prior Research This Research

• To use stock prices as an dependent

variable to evaluate the usefulness of

reported earnings

• To use trading volumes as well as stock

prices as an dependent variable to

evaluate the usefulness of reported

earnings

Changes in the

expectations of the

market as a whole

12/13

Price test

Changes in the

expectations of

individual investors

Volume test

Section 6. Contribution and Sugges-tion

Suggestions for Future Research

• To explore the possibility of constructing expectations models

that will permit a prediction of the direction and magnitude of

the price residual• Ball and Brown(1968), Beaver-Clark-Wright(1979)

13/13

• To apply this methodology to other types of news

announcements• Green and Segall: interim earnings reports• Dividend announcements

• “Should decision makers perceive earnings reports to possess

information value?

• To select an event of interest to decision makers and to

investigate the ability of earnings data to predict that event

Section 6. Contribution and Sugges-tion

Suggestions

1

Expectation model

2

Other types of news

announcements

3

Normative issue

Expansion of Research

May (1971) • 분기별 회계이익이 공시되는 주에도 주식수익률분산이 증가함을 실증

13/13

Section 6. Expansion of Research

Morse (1981)

Atiase (1985)

Hagerman- Zmijew-ski-Shah(1984)

• 이익공시일 전후의 일자별 주가변동과 거래량증감 분석• 회계이익공시일 전일에 가장 높은 주가변동과 거래량 증가

• 대기업과 소기업의 이익공시 주의 주가변동 차이비교• 대기업 4.2% 증가 vs 소기업 115.9% 증가

• 이익공시주간 전후 3 일간의 초과수익률과 unexpected earning

간의 상관관계 조사• 이익공시일 전후의 주가변동방향과 unexpected earning 의 부호

(good news/bad news) 간에 높은 상관관계