The Information Content of
Annual Earning
Announcements
William H. Beaver
Journal 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
Section 1. Motivation
Motivation
Valuation
theory
a 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
equation
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
Motivation
To provide empirical evidence to ascertain whether accounting numbers
contained or conveyed information about a firms financial performance
2/13
Section 2. Research Question and Conclusion
Research Question and Conclusion
Does common stock investors perceive earnings to
possess informational value ?
Definition. of Information
Change in expectations
about the outcome of an
event
Sufficiently large change
to induce a change
in the decision-makers
behavior
A firms 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
If it leads to an altering of the optimal holding of that firms
stock in the portfolios of individual investors
Shift in portfolio position would be reflected in the volume
Expectations of individual investors and the market as a whole
are altered by the earnings report
Earnings reports possess information content
3/13
Section 2. Research
Question
Primary Research method
Analyze investor reaction to earnings announcement,
as reflected in the volume and price movements of
common stocks in the weeks surrounding the announcement
date
Earnings
announcement
Different
interpretation
among investors
Increasing
volume before a
consensus is
reached
Lack of
consensus
regarding the
price
Volume
test
Changes in the
expectations of
individual investors
4/13
Change in
equilibrium
value
If risk
preferences
differ, volume
reaction
Price
test
Changes in the
expectations of the
market as a whole
Section 3. Sample and
Data
Sample and Data
Sample and Data Collection
Sample period: 1961~1965
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
announcements
6. Less than 20 news announcements per
year appearing in the WSJ
143 firms
506 annual earnings announcements
5/13
Section 4. Empirical
Test
Volume Analysis-Unadjusted for Market Influence
Results
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
Vjt = Computed for each week t in the report period for each
of the 506 earning announcement j
Earnings reports have information content
6/13
Section 4. Empirical
Test
Volume Analysis-Adjusted for Market Influence
Results
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
Nonreport
period
Report
period
Earnings reports have information content
7/13
Section 4. Empirical
Test
Price Analysis-Adjusted for Market Influence
Hypothesis
If 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 securitys
firm-specific price change
Nonreport
period
u2 it
= the square of residual (to
eliminate the effect of the signal of
residual)
si2 = mean of u2 it during the nonreport
period (= Var(u2it ))
Report
period
8/13
Section 4. Empirical
Test
Price Analysis-Adjusted for Market Influence, continued
Results
Earnings reports have information content
9/13
Section 5. Empirical
Result
Empirical Result
Analysis
The information contents of
annual earnings announcements
Empirical Results
Volume
(unadjusted)
The largest increase in volume
in the announcement week
Volume
(adjusted)
3
Price
(adjusted)
The largest change in price in
the announcement week
Not only are expectations of
individual investors altered by
earnings report,
But also the expectations of the
market as a whole.
10/13
Section 5. Empirical
Result
Relationship between the Volume and the Price Findings
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
the market price, whether or not they engage in
changes on each transaction
a purchase or a sale
The variance of the weekly price change will
The total number of transactions, explicit
increase in direct to proportion to the number
and implicit, are the same per time period
of transactions that occur during the time
period
Changes in _price
activity (Ut)
= 1.67
The expectations of the all investors influence
_
More action (et ) = 1.3
Changes
in _price activity
Changes in
equilibrium prices =
0.37
(Ut)
_
More action (et ) = 0
Changes in equilibrium
prices = 1.67
= 1.67
Additional empirical research is needed before this issue will be resolved.
11/13
Section 6. Contribution and
Suggestion
Contribution
Prior Research
This Research
To use stock prices as an dependent
To use trading volumes as well as stock
prices as an dependent variable to
variable to evaluate the usefulness of
evaluate the usefulness of reported
reported earnings
earnings
12/13
Volume test
Price test
Changes in the
expectations of
individual investors
Changes in the
expectations of the
market as a whole
Section 6. Contribution and
Suggestion
Suggestions for Future Research
Suggestions
1
Expectation model
Other types of news
announcements
Normative issue
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)
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
13/13
Section 6. Expansion of Research
Expansion of Research
May (1971)
Morse (1981)
Atiase (1985)
4.2% vs 115.9%
HagermanZmijewski-Shah(1984)
3 unexpected
earning
unexpected earning
(good news/bad news)
13/13
