Share Price Reactions to Earnings Announcements: An Event Study

An event study is a research technique used to measure how investors react to corporate announcements or news, in order to see whether there are abnormal returns.

Companies carefully plan when and how they report earnings, with many opting for early announcements to gain media coverage and take advantage of any announcement premium. They also choose the day for announcement: after-hours announcements see roughly a half percentage point premium over pre-open releases.

Stock Price Reactions to Earnings Announcements

Investors rely heavily on earnings announcements for vital insight into a company’s financial performance. But the days preceding these events can often be filled with speculation; analyst predictions can often miss the mark and investors may overreact in response to positive or negative earnings surprises.

UCLA Anderson professor Henry L. Friedman and graduate student Zitong Zeng have combined forces in an innovative new study to investigate the impact of retail (individual or individual) traders in reacting to earnings announcements in markets. They find that stocks with higher concentrations of retail trading activity experience greater immediate price reactions as well as post-announcement drift.

The authors provide evidence of several factors influencing these results, including stock prices reacting less strongly to positive earnings reports when market sentiment is negative or bearish (i.e., bearish market). Initial underreaction may also increase when an announcement follows an unfavourably received one or when firms simultaneously release 10-K filings with it (Kosa and Zhang 2019). Finally, analysts’ forecast errors help minimize initial underreaction by providing another sign that relevant information has been disclosed (Kosa and Zhang 2019).

Stock Price Reactions to Dividend Announcements

In this paper, we analyze stock price reactions to dividend announcements using daily data from the CRSP. We found that standard parametric event study tests produced robust results when applied to daily returns data. Furthermore, our analysis shows that both good news categories were rejected at conventional one to five percent significance levels multiple days following earnings announcements.

Publicly traded companies must report quarterly earnings, creating an intricate dance between corporate officials dispensing earnings guidance and professional analysts tasked with forecasting quarterly earnings estimates. Studies of earnings surprises and stock prices have focused primarily on how positive surprises affect share prices immediately after being announced.

There is limited research that investigates the effect of negative earnings surprises on share prices, but this article extends this investigation to examine dividend announcements as well and finds that stocks react negatively when these occur; consistent with signaling theory.

Stock Price Reactions to Share Splits

An impending stock split announcement provides managers with a way to signal private information about a firm’s prospects, with investors responding positively when forward split announcements are announced, but negatively when reverse split announcements are announced. Studies indicate that investors react more favorably when forward stock splits are announced than reverse stock splits are announced.

These results support the hypothesis that managers use splits as signals of future earnings potential in their firms. An initial underreaction after three splits coincides with abnormal profitability, suggesting management has succeeded in communicating positive information through its split announcements. Over time however, this underreaction dissipates until by the sixth split the impact of announcement has become lessened.

By employing standard risk adjusted event study methodology, we examine how public announcements of two for one and three for two forward and reverse stock splits impact market reactions to these events. We find that stocks had positive reactions up to 27 days prior to each split announcement before its positive effect began to fade with each successive one.

Stock Price Reactions to Share Repurchases

Share repurchases are widely interpreted by the market as signals that firms perceive their stocks to be undervalued, with studies finding significant positive abnormal returns following announcements of share repurchases (Ikenberry et al. 1995 and Lie 2005).

However, these results are derived from mature capital markets which may limit their applicability in emerging markets. To assess this issue more adequately for China specifically, this paper uses event study analysis to investigate how open market share repurchase announcements affect stock price synchronicity in China.

Particularly, this study investigates the influence that retail traders – as nonprofessional investors – play in shaping market reactions to earnings surprises. Research shows that stocks that attract large groups of retail traders tend to display stronger reactions both immediately after earnings surprises are released and into subsequent trading sessions; this effect becomes even stronger for stocks with strong predicted volume increases over the announcement months and strong buying patterns on announcement days from retail investors.