Do Securities Markets Respond to Earnings Paths? A Case for Low-Balling

Abstract

Earnings paths are proxied by analyst forecasts leading up to the earnings announcement. We find that after controlling for information content, as revealed by the earnings announcement, security returns measured over the entire quarter are affected by the path of expected earnings. We uncover cases of perverse market response in which security returns are significantly non-zero when the earnings announcement contains no information. We also observe cases in which positive information elicits negative or no market response, and negative information elicits a positive market response. These results suggest management may have an incentive to low-ball interim earnings expectations. Finally, we find that the bulk of the anomalous returns remain after attempts to relate them with alternate explanations such as shifts in risk, spillover effects, and the possibility of market overreaction.

JEL Classification: D84