Do record earnings affect market reactions to earnings news?
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Do record earnings affect market reactions to earnings news? Juwon Jang1 · Eunju Lee1
© Springer Science+Business Media, LLC, part of Springer Nature 2020
Abstract We find evidence that a firm’s record earnings influence market response to earnings news. Our results show that the proximity of the firm’s earnings to its record earnings leads to investors’ underreaction following earnings announcements, exacerbating post-earningsannouncement drift. Such biased behavior is more pronounced in low-growth firms and firms with low institutional ownership. Meanwhile, analysts are not subject to this anchoring bias when a firm’s earnings are close to its record earnings. Overall, we find that a firm’s record earnings play an important role as an anchor when market participants evaluate the firm’s earnings news. Keywords Record earnings · Anchoring bias · Post-earnings-announcement drift · Analyst forecast revisions JEL Classification G11 · G41
1 Introduction Firms’ announcements of record earnings often generate large stock price movements, suggesting that market participants pay attention to this benchmark. For instance, when Amazon.com Inc. reported its record profit on July 28, 2016, its stock rose 4% before market open on the next day.1 When Tyson Foods Inc. projected record profits in February 2016, its stock hit a historical high of $75.46.2 Increases in stock prices will be a natural consequence of new earnings records if the earnings convey information about improved fundamental values. However, record earnings per se indicate a firm’s highest earnings in 1 See the Wall Street Journal article “Amazon Posts Another Blockbuster Profit” released on July 28, 2016, at http://www.wsj.com/articles/amazon-posts-another-blockbuster-profit-1469736704. 2 See the Wall Street Journal article “Tyson Foods Projects Record Profits; Shares Hit All-Time High” released on February 5, 2016, at http://www.wsj.com/articles/tyson-foods-beats-profit-expectations-boost s-outlook-1454678628.
* Eunju Lee [email protected] Juwon Jang [email protected] 1
University of Massachusetts Lowell, 72 University Avenue, Lowell, MA 01854, USA
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its history. Therefore, how far a firm’s current earnings are from the record earnings would not provide further information about the firm’s growth prospects or future fundamental values. By evaluating firms’ earnings news and making investment decisions based on this benchmark, investors could misprice stock and reduce informational efficiency in the equity market. We find evidence of an “adjustment and anchoring” bias associated with firms’ record earnings. Firms whose earnings are close to their record earnings experience higher subsequent returns, while those whose earnings are far from their record earnings have lower subsequent returns. This suggests that investors underreact to earnings news as a result of their anchoring based on the distance of firms’ earnings to their record earnings. This underreaction exacerbates the well-know
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