In this post we investigate whether investors are paying attention to earnings events and find that investor activity spikes over 150% after earnings events.
Background
Publicly traded companies in the United States are required to periodically report important business and financial information to the public. The U.S. Securities and Exchange Commission requires that the dissemination of this information is done in a fair manner (per Regulation Fair Disclosure) so that all investors have equal access to this “material” information. Companies have generally adopted the framework of issuing press releases with highlights about their financial results followed by a conference call with interested investors and finally an issuance of the annual or quarterly report required by regulations. The release of this information is called an “earnings announcement” in investor parlance.
The foundations of modern finance are based on understanding and ultimately forecasting future financial results…
Given the importance of the information included in these reports, investors tend to pay close attention to them and spend considerable time understanding how they impact a company’s valuation. The foundations of modern finance are based on understanding and ultimately forecasting future financial results in order to determine the value of the claim to equity of a company. Consequently, as companies release new information about their performance, investors respond by buying shares of companies they deem undervalued and selling shares of companies they deem overvalued.
Empirical Investigation
In this section we empirically establish our prior claim that investors pay close attention to events. While no perfect tool to measure investor attention exists, we take the standard approach of using trading activity as a proxy for it. Specifically, we study volume and price changes before and after earnings announcements. In the analysis that follows we make use of our proprietary event dataset during the period 1/1/2012 to 1/1/2017 which contains 57,678 unique events.
To study trading activity for events, we timestamp each event according to when the information was initially disseminated publicly. We ignore any announcements that are released during market hours so that our analysis can focus on more achievable prices at the open and close of trading. Each event is assigned an “event day” that represents the first day when the market is open subsequent to the event release. For events that occur after the close, the event day is the next trading day while the event day for events that occur before the market open is that day.
Instead of using trade volume for this analysis, we use daily trade value (defined as volume multiplied by the close price) since we believe it does a better job of capturing investor attention. For every stock in our event dataset we calculate trade value on each day during the sample period. Then we mark every event day and the first trading day immediately prior to each event day. Because large differences exist in trade value across stocks we aggregate the results by taking an average cross-sectionally. If we did not take this step, companies with the largest trade activity would dominate and small companies would not be fairly represented in the results.
We are interested in learning about investor attention both before and after an event. We define an event “jump” return as the natural log of the close price on the event day divided by the close price on the day before the event. Similarly, we define a “reaction” return as the natural log of the close price on the event day divided by the open price on the event day. In this section we focus on absolute returns since we are not interested in directional movements in establishing investor attention.
Activity around events is indeed higher relative to other days. On days before an event, trade value is slightly higher with 24% more trade value than all other days. On event days, we observe 159% more trade value than on other days. To the extent that trade activity acts as a proxy for investor attention, it is clear that investors are paying close attention to these events. To see if differences exist in investor attention depending on the content of the event, we look at the trade activity based on the direction of the jump return and reaction return. While small variations exist in these groups we do not make any meaningful conclusions from them.
In our next post, we will continue this investigation by looking at how price changes and volatility respond to events.
To read Part 2, click here.
Disclaimer
This material is solely for informational purposes and is not an offer or solicitation for the purchase or sale of any security, nor is it to be construed as legal or tax advice. References to securities and strategies are for illustrative purposes only and do not constitute buy or sell recommendations. The information in this report should not be used as the basis for any investment decisions. We make no representation or warranty as to the accuracy or completeness of the information contained in this report, including third-party data sources. The views expressed are as of the publication date and subject to change at any time. Hypothetical performance has many significant limitations and no representation is being made that such performance is achievable in the future. Past performance is no guarantee of future performance.