Are Audited Annual Earnings Less Noisy than Interim Earnings?

Abstract

Prior empirical research has typically found a difference between fourth-quarter and interim earnings, both in terms of the accuracy of earnings forecasts and the stock price response evoked. However, a differential stock price response to fourth-quarter earnings could be due to a variety of factors, such as interim errors being corrected during the annual audit, errors being introduced by fourth-quarter management manipulation, or transitory earnings shocks being more common in the fourth quarter. This study adopts a technique that can better distinguish between the competing hypotheses than prior work. Our evidence is consistent with prior findings that fourth-quarter earnings are somehow different. But the difference cannot be solely attributed to the annual audit correcting interim errors, which rejects one of the more popular conclusions in the prior literature. Instead, the results are most consistent with increased recognition of transitory earnings in the fourth-quarter.

JEL Classification: M4