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Stock Price Reaction to Earnings Information

Johannsen, Matthias

Studienreihe der Stiftung Kreditwirtschaft an der Universität Hohenheim, Vol. 47

(2010)

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Abstract

This work investigates the reaction of capital market participants to information contained in financial statements of German public limited companies. The application of accounting standards requires discretion which may be exercised to pursue opportunistic incentives or incentives to increase the information content of financial statements. This work explores these issues and is structured in two main parts. Using annual data of 850 firms listed on German stock exchanges for the years 1990 to 2003 it is shown in the first part that stock prices react only gradually to earnings information. This finding supports the post-earnings announcement drift. In the second part it is demonstrated that for cases with incentives for opportunistic earnings management and with high (low) degrees of earnings management, share prices react more (less) gradually to earnings information.

Table of Contents

Section Title Page Action Price
Table of Contents 5
Tables 8
Figures 9
Appendices 10
Abbreviations and Variables 11
1. Problem outline 17
2. Investigation of the post-earnings-announcement drift in Germany 21
2.1 Introduction 21
2.2 Current state of academic discussion 22
2.2.1 The concept of market efficiency 22
2.2.2 The post-earnings-announcement drift 22
2.2.2.1 Implications for market efficiency 22
2.2.2.2 Summary of evidence 23
2.2.3 Existing explanations for the post-earnings-announcement drift 26
2.2.4 Commentary on existing explanations 27
2.3 Research design 29
2.3.1 Research methodology 29
2.3.2 Considered variables for a risk-based investigation 33
2.3.3 Hypotheses development 36
2.4 Sample construction 37
2.4.1 Data collection 37
2.4.2 Variable computation 37
2.4.2.1 Unexpected earnings 37
2.4.2.2 Unexpected earnings portfolio formation 40
2.4.2.3 Risk-related variables 41
2.4.2.4 Abnormal returns 43
2.5 Data analysis 45
2.5.1 Investigation of hypothesis 1 45
2.5.1.1 Cumulative abnormal returns of unexpected earnings portfolios 45
2.5.1.2 Significance tests of the cumulative abnormal returns 50
2.5.2 Investigation of hypothesis 2 58
2.5.3 Investigation of hypothesis 3 60
2.5.3.1 Analysis of covariance 61
2.5.3.2 Sub-samples based on size and book-to-market ratio 66
2.6 Conclusion 72
3. Investigation of the capital market reaction to earnings management 75
3.1 Introduction 75
3.2 Current state of academic discussion 76
3.2.1 General concept of earnings management 76
3.2.2 Incentives of earnings management 77
3.2.2.1 Types of incentives 77
3.2.2.2 Incentives of opportunistic earnings management 78
3.2.2.3 Incentives of informative earnings management 81
3.2.3 Capital market reaction to earnings management 82
3.2.3.1 Concealing effect of earnings management 82
3.2.3.2 Informative effect of earnings management 83
3.2.4 Summary 84
3.3 Research design 84
3.3.1 Theoretical considerations 84
3.3.2 Hypotheses development 86
3.3.3 Research methodology 88
3.4 Sample construction 90
3.4.1 Data collection 90
3.4.2 Variable computation 91
3.4.2.1 Earnings management variables 91
3.4.2.1.1 Different approaches to measure earnings management 91
3.4.2.1.2 Comment on the different approaches 95
3.4.2.1.3 Used measures of earnings management 98
3.4.2.2 Earnings informativeness variables 100
3.4.2.3 Control variables 107
3.4.2.4 Absolute cumulative abnormal returns 109
3.5 Data analysis 111
3.5.1 Correlations among key variables 111
3.5.2 Investigation of hypotheses 1 and 2 113
3.5.3 Investigation of hypothesis 3 118
3.5.3.1 Hypothesis tests 118
3.5.3.2 Fixed effects panel regressions 123
3.6 Conclusion 134
4. Summary 137
4.1 Main results 137
4.2 Implications for market participants 138
4.3 Implications for accounting standard setters 139
4.4 Implications for future research 139
References 141
Appendices 155