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1. Introduction
Several studies on the relationship between earnings reports and
security price behavior provide evidence suggesting that a significant
The evidence above reflects an "average finding" across all firms. One
question of interest is whether there are significant systematic cross-
sectional differences in the security price reactions to earnings announcements of firms which are associated with specific firm characteristics
ment, University of California, Berkeley, for which I am grateful. [Accepted for publication
August 1984.]
1 Grant [1980] suggests that another firm-specific characteristic is the market in which
a firm's equity securities are traded (i.e., an "exchange effect"). He observed that the
average security price reaction to the earnings announcements of over-the-counter (OTC)
firms was significantly higher than those for New York Stock Exchange (NYSE) firms.
21
Copyright ?), Institute of Professional Accounting 1985
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vided by Atiase [1980], who argues that the amount of private predisclo-
and Ro [1984]) have found results consistent with the findings reported
here.
2. Empirical Procedures
The study covered the four-year period, 1969 through 1972, with weekly
security price revaluations examined in response to second-quarter earnings reports of 200 sampled firms in 1971 and 1972.3 Regression analysis
was used to test the hypothesis that the degree of a firm's security's price
revaluation in response to its earnings announcement was inversely
related to the firm's capitalization. Details of the sample design, variable
first-quarter earnings tend to be released along with, or close to the time of, annual earnings
announcements. Similarly, May [1971] found that first announcements of dividend changes
are made more frequently during the fourth quarters of firms' operating years along with
or close to third-quarter earnings announcements. The number of years covered by the
study was largely constrained by the extensive data gathering involved in generating weekly
returns for the OTC firms. Nevertheless, there is no a priori reason to believe that the
research question of interest or the results of the study would be period specific.
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PREDISCLOSURE INFORMATION 23
of RSCV firms. Criteria (1) and (2) were replaced by (la) the firm's
equity securities had to have been traded OTC for the entire 1969-72
period; and (2a) the firm had to have been listed in the Investment
Statistics Laboratory (ISL) Daily Stock Price Index-OTC, with complete
data on stock prices, dividends, and capital changes available for the
entire 1969-72 period.
2.2 DATA COLLECTION
Weekly return relatives for each NYSE/AMEX firm, along with weekly
market return relatives, were computed from daily CRSP tapes for the
period 1969-72. Fisher's Value-Weighted Index was used for the market
returns. For the 50 OTC firms, data on weekly closing bid prices, cash
dividends, stock dividends, and stock splits were manually gathered from
the ISL Daily Stock Price Index-OTC for the four-year period, 1969
through 1972 inclusive, and used to compute weekly return relatives for
each of these OTC firms.
The final data consisted of 200 second-quarter earnings announcements, one each for 100 RSCV and 100 RLCV firms. The capitalized
values (CVs) of the firms included in the sample ranged from $1.80
million to $19.98 million (RSCV firms) and from $426.23 million to
$38.88 billion (RLCV firms).
4 The same restriction would have been applied to earnings announcements published
in a Tuesday WSJ if the previous Monday turned out to be a public holiday; but, this
problem was not encountered.
In fact, personal consultation with the San Francisco office of Dow Jones, Inc.,
publishers of the WSJ, confirmed that is generally the case.
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2
3
7
8
11
31
19
19
34
38
21
17
59
15
10
8
9
9
3
10
4
5
2
1
74
84
93
96
100
6
37
71
88
92
97
99
100
100
The dates of the earnings announcements were obtained from the Wall
Street Journal Index (WSJI) and were cross-checked with the WSJ.
Table 1 reports comparative time lags between the financial statement
dates (June 30, 1971 [1972]) and the announcement dates for the RSCV
firms and the RLCV firms. For the RSCV and RLCV firms, the median
time lags were five and four weeks respectively, and all announcements
were made by the RSCV and RLCV firms by the end of ten and nine
weeks respectively.
The returns history was divided into an estimation period (EP) of 104
weeks and a test period (TP), which was further divided into a predisclo-
sure period (PP), and a report period (RP). The report period (RP) was
defined as the seven weeks surrounding the announcement date (ranging
from three weeks before the announcement week, week zero, to three
weeks after). Two basic definitions of the predisclosure period (PP) were
employed: (i) the period between the beginning of the fiscal period and
the beginning of the report period (P); and (ii) the period between the
beginning of the fiscal period and the end of the second quarter (P').
Thus, P takes into consideration the differences in the time lag between
the financial statement date and the announcement dates of the various
sampled firms, while P' does not. Figure 1 depicts the research design.
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PREDISCLOSURE INFORMATION 25
Rit = the natural logarithm of the return relative for firm i in week t;
Rmt = the natural logarithm of the return relative for the market
portfolio in week t;
tions which were not used in the estimation of ai and bi, they do not
Predisclosure period (P) Ea
P Loq
13cjipiiing 1969 (1970) End 1970 (19-71)
ki-
1971
week
(1972)
'The average bi over the entire sample was 0.97, and 0.99 and 0.95 for the RSCV and
RLCV firms respectively. None was significantly different from 1.00 at the 10% level.
Hence, the sampled firms did not appear to be members of a particular segment of the
systematic risk spectrum. For the entire sample, the average R2 for the market model
regressions was 0.214, which is higher than that observed for NYSE firms by Beaver [1968],
Patell [1976], and Grant [1980] for weekly returns data in periods 1961-65, 1963-69, and
1960-64, respectively. However, the average R2 for the RSCV firms was only 0.113, compared
to the corresponding figure of 0.315 for the RLCV firms. Accordingly, it seemed necessary
to test the sensitivity of my results for these firms. (Results reported below show that the
average report week price revaluation of the RSCV firms is significantly [uniquely] higher
than the theoretical expectation and the averages in the other weeks in the report period.)
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represent residuals in the OLS sense. However, under the OLS regression
assumptions, and the hypothesis that these assumptions hold during the
TP, the ait are distributed as:
-.i2 S.2 =
E tEPS 6 (6)
E
t EEEP
tiT - 2
Cist*
= (Rmt
Rm)(Rms - Rm) t* E TP, (7)
Cs*T+
T
E (Rmt -Rm)2
t=1
t=1
assumptions were made that the return distributions were Normal with:
in the case of this study), cov(ais, ait) 1. 0, for s $ t*. The Cit* term
reflects the increase in variance due to prediction outside the estimation
the EP, and how far market returns deviate from past averages.' Notice
however, that (10) implies cross-sectional independence of residuals in
the TP and ignores correlations such as the industry effects noted by
King [1966], and the extra-market covariance return arising from common factors noted by Rosenberg [1974] and by Rosenberg and Marathe
[1976]. These are controlled for later, although in any event, recent
evidence by Collins, Rozeff, and Salatka [1982] and Oppong [1980]
8 See Collins and Dent [1984].
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PREDISCLOSURE INFORMATION 27
during predisclosure periods. This index provides a completely endogenous control for predisclosure information.
expectations, the sign of the report week unexpected returns, uit, could
not be specified ex ante. This motivated the use of u U , which is essentially
an estimate of the variance of the unexpected return in the report week.
u. for the report week for each firm was standardized by the EP residual
variance. Dividing the resulting F statistic by its expected value provides
Var(RIit*) --(T
2(T-6)3)
'Indeed, Collins, Rozeff, and Salatka [1982] found that even for abnormal returns
measured at a common point in calendar time for firms from the same basic industry (oil
and gas production), the average level of cross-sectional correlation in weekly residuals was
only 0.067. Besides assumption (10), Oppong [1980] also provides evidence in support of
assumption (5).
" RI is similar to measures used by Beaver [1968] and Patell [1976]. For a detailed
derivation of RI and its distributional properties, see Atiase [1980] or Patell [1976].
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For an intuitive interpretation, the RIi for the report week, RIjo, may
RIjo greater than 1.0 would imply that the earnings report conveyed more
than average information during the estimation period, and vice versa.
Similarly, the average RIi, over the predisclosure period may be intuitively
RIi,* for each sampled firm can be standardized by the average RIj, over
statistics:
PiIX
RIt
E t= t
For comparability across firms whose Pi values differ, the statistics in
(12) and (13) are scaled by their expected values to give the Standardized
Revaluation Indices-SRI1 and SRI2 respectively, distributed as given
below:
Pi
PtEP
tEXRIit
Pi t=1
E(SRI1st*)
1,
(14)
Var(SRIlit*) = (Pi - 1)
Pi. t= 1
E(SRI2it*)
1,
(15)
Var(SRI2it*) = 2(P' - 1)
12 This is a convenient property for the final regression models. In particular, if one
assumes that the model specifications are translation invariant, the constant variance
property ensures homoscedasticity.
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PREDISCLOSURE INFORMATION 29
SRI1io and SRI2jo. Hence, each firm i acts as its own endogenous control.
RIj, SRI1j, and SRI2j were computed for each of the seven weeks of the
report period.
A priori, the superiority of SRI1 over SRI2 lies in the fact that the
former allows control for differences in the time lag between the financial
3. Results
Analyses were performed at a portfolio level, to test the uniqueness of
Tables 2, 3, and 4 report the estimated averages of RI, SRI1, and SRI2
(i.e., RI,SRI1 and SRI2 respectively) in each week in the report period
for the following five portfolios: (1) total sample, (2) total subsample of
RSCV firms, (3) RSCV OTC firms only, (4) RSCV NYSE/AMEX firms
only, and (5) the subsample of RLCV firms.
The results obtained for SRI1 (table 3) are consistently stronger than
those for SRI2 (table 4), as expected. Nevertheless both sets of results
show essentially the same patterns. For ease of exposition, then, the
discussion is limited to RI and SRI1.
Estimated Average RI
Sample Description
-2
-1
+1
+2
+3
Total sample ............ 0.767 0.549 1.133 2.026a 0.805 0.866 0.837
RSCV firms:
Total subsample ......... 0.763 0.564 1.256 3.2268 0.547 0.674 0.556
OTC firms only ......... 0.532 0.282 0.837 3.843a 0.581 0.759 0.457
NYSE/AMEX firms only. 1.019 0.877 1.720 2.543a 0.510 0.579 0.666
RLCV firms .............. 0.771 0.533 1.009 0.814b 1.064 1.061 1.120
aSignificantly higher than both the E(RI) and the RIs in the other weeks in the report period at an
a-level of less than or equal to 0.005.
b Not significantly different from the E(RL) or the RIs in the other weeks in the report period at any
meaningful level of a.
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Sample Description
-3
-2
-1
+1
+2
+3
Total sample ............ 0.764 0.540 0.952 1.611a 0.794 0.795 0.800
RSCV firms:
Total subsample ......... 0.613 0.438 0.814 2.377a 0.433 0.457 0.451
OTC firms only ......... 0.550 0.344 0.809 2.9398 0.437 0.603 0.413
NYSE/AMEX firms only. 0.684 0.543 0.819 1.7548 0.427 0.296 0.493
RLCV firms .............. 0.917 0.642 1.091 0.838b 1.159 1.137 1.151
a Significantly higher than both the E(SRI1) and the SRIls in the other weeks in the report period
at an a-level of less than or equal to 0.005.
b Not significantly different from the E(SRI2) or the SRIls in the other weeks in the report period
at any meaningful level of a.
TABLE 4
-3
-2
-1
+1
+2
+3
Total sample ............ 0.745 0.532 0.950 1.5808 0.786 0.785 0.788
RSCV firms:
Total subsample ......... 0.594 0.426 0.817 2.3238 0.424 0.445 0.434
OTC firms only ......... 0.524 0.329 0.815 2.8918 0.438 0.590 0.397
NYSE/AMEX firms only. 0.671 0.533 0.820 1.6598 0.408 0.284 0.475
RLCV firms .............. 0.897 0.638 1.083 0.829b 1.152 1.131 1.146
aSignificantly higher than both the E(SRI2) and the SRI2s in the other weeks in the report period
at an a-level of less than or equal to 0.005.
b Not significantly different from the E(SRI2) or the SRI2s in the other weeks in the report period
at any meaningful level of a.
were 2.026 and 1.611, 103% and 61% higher than their theoretical
expectations respectively. The theoretical variances of the RIo
and SRIl0 for this portfolio were 0.0103 and 0.0114 respectively.
Hence both the RIo and SRIlo were significantly higher than 1.000 at an
al-level of less than or equal to 0.005. As a result, we can conclude that
irrespective of the extent of information production and dissemination
about individual sampled firms, the average earnings report week price
revaluations (for the entire sample) were 103% higher than the average
during the estimation period (104 weeks) and 61% higher than the
average during the predisclosure period (26 weeks on average). These
results are consistent with those reported by Beaver [1968] and May
[1971].
the E(RI)). The respective SRITo of the above portfolios were 2.377,
2.939, and 1.754 (138%, 194%, and 75% higher than the E(SRI1)). Again,
the averages were significantly higher (a c 0.005) than their theoretical
expectation of 1.000 and their RI and SRI1 in the other weeks in the
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PREDISCLOSURE INFORMATION 31
report period. These results suggest that tests of the main hypothesis
below should be robust enough even with the use of a single market
model and market return index for all the sampled firms (including the
OTC firms).'3
were 0.814 and 0.838, for RIo and SRIlo respectively, or only 19% and
16% lower than the theoretical expectation of 1.000, neither of which is
significant at any meaningful level of a. The RIO and SRI10 were also
not significantly (uniquely) different from the averages in the other
weeks in the report period. I should note that my results for the RLCV
firms and the RSCV OTC firms are consistent with the results reported
by Grant [1980], as are the relatively higher average report week price
each of the seven weeks in the report period of each firm has an equal
NYSE/AMEX firms, the report week SRIli was largest in the sevenweek report period for 81, 66, 41, and 25 firms, respectively. Assuming
the null hypothesis that P = 1/7, the probability of observing equal or
greater frequencies than these observed frequencies for each of the
portfolios is less than 0.0001. Thus the abnormally high SRI10 (and RIo)
observed were not just due to extreme price revaluations around the
earnings announcements of a few firms. For the portfolio of the RLCV
NYSE/AMEX firms, however, the report week SRIli was the largest in
the report periods for only 15 out of 100 firms, which results in a rejection
of the null hypothesis at an a-level of 0.4129. Overall, then, the results
of the parametric and nonparametric tests are consistent with each other.
13 The uniqueness of the report week RI (SRI1) relative to the other weeks in the report
period (particularly for the RSCV firms) also suggests that the results of this study should
not be affected significantly by the "size effect" noted by Banz [1981] and Reinganum
[1981], or the "January/turn-of-the-year effect" noted in Keim [1983] and Roll [1983]. In
fact, the latter would tend to induce a bias against supporting the main hypothesis of this
study, since the residual variance of the RSCV firms, which are smaller than the RLCV
firms, would tend to be more biased upward during the estimation and predisclosure periods
(see the results of Banz [1981] and Reinganum [1981]).
14 Additional comparisons between Grant's "exchange effect" and the "size effect" are
made in a separate study (Atiase [1984]).
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Ho: A3 = 0
versus:
H1: A1 < 0.
3.3 FINAL REGRESSION RESULTS (INDIVIDUAL-LEVEL ANALYSIS)
The deciles of the estimated values of the variables for the final
regression models for LCVj, RIjo, SRIlio, and SRI2jo across the total
sample, the subsample of RSCV firms, and the subsample of RLCV firms
TABLE 5
1.384
0.039
0.049
0.048
.20
1.711
0.175
0.211
0.202
.30
1.978
0.439
0.420
0.420
.40
2.400
0.681
0.677
0.639
.50
2.995
1.015
1.007
0.983
.60
6.549
1.374
1.215
1.207
.70
6.738
1.913
1.718
1.705
.80
7.009
2.745
2.588
2.531
.90
7.749
4.485
4.245
4.011
TABLE 6
1.067
0.755
0.490
0.490
.20
1.384
1.014
0.789
0.728
.30
1.556
1.229
1.027
0.986
.40
1.700
1.505
1.193
1.144
1.411
.50
1.851
1.838
1.533
.60
1.978
2.132
1.951
2.008
.70
2.189
3.115
2.636
2.613
.80
2.400
4.384
3.889
3.708
.90
2.573
6.046
4.840
4.945
Maximum
2.995
28.788
10.887
12.540
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PREDISCLOSURE INFORMATION 33
TABLE 7
Decile
LCV,
RIo
SRI1,o
SRI2jo
.10
6.424
0.005
0.009
.20
6.549
0.039
0.049
0.006
0.048
.30
6.621
0.108
0.116
0.116
.40
6.738
0.174
0.211
0.202
.50
6.869
0.345
0.407
0.382
.60
7.009
0.505
0.599
0.595
.70
7.309
0.712
0.889
0.889
.80
7.749
1.185
1.327
1.363
.90
8.823
2.078
2.212
2.206
Maximum
10.568
4.829
5.936
5.936
TABLE 8
Final Regression Results (t-statistics in parentheses)
Regression
Model No.go0R
1
.................
4.019
(9.71)a
.................
2.763
-0.440
f1i
0.144
(5.74)a
-0.254
0.136
(11.29)a (5.53)a
3
.................
2.687
-0.244
0.127
(11.04)a (5.33)a
One-sided test:
only a little over 50% of the total sampled firms had SRI1io (RIjo) greater
than the theoretical expectation of 1.000 (table 5). Further, while the
SRIlio (RIio) of over 70% (80%) of the RSCV firms (table 6) were above
the expected value, over 70% (almost 80%) of the SRIlio (RIjo) of the
RLCV firms (table 7) were below the expected value.
The final regression results reflect the general relationship between
the report week price revaluations, earnings announcements, and firm
capitalization. The results of the three regression models17 are reported
in table 8. The results of the regression models were supplemented with
correlation tests based on the nonparametric Spearman rank-order correlation coefficient'8 and on the parametric Pearson product-moment
17 Diagnostic tests suggest that the regression models are fairly well specified, with little
evidence of heteroscedasticity and only moderate departures from normality (based on the
Kolmogorov-Smirnov goodness-of-fit test).
levels of the negative coefficients) were the same as those for the estimated Spearman
rank-order correlation coefficients. Thus, only the latter results are reported here.
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TABLE 9
Results of Correlation Coefficients Between LCVi (the Size Variable) and Report Week
Revaluation Indices (Significance levels in parentheses)
Spearman Pearson
Dependent Rank-Order Product-Moment
Variables Correlation Correlation
Coefficient Coefficient
RI0o
.........
-0.548
(0.0001)*
SRIlio
........
-0.405
(0.0001)*
SRI2io
........
-0.401
(0.0001)*
-0.380
(0.0001)*
-0.368
(0.0001)*
-0.357
(0.0001)*
* Significance level.
The final regression results are quite robust across the various model
specifications, although model 2 (dependent variable is SRIlio) slightly
4. Conclusions
Subject to limitations that may be due to sample sizes, selection
criteria, and assumptions underlying the model specifications, the em19 In a simple regression model where, for example, Y = do + f1X + E, o - Y - flX.
Thus, since d, is negative, do = F + I d, 1. X, which should be greater than Y.
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PREDISCLOSURE INFORMATION 35
pirical results presented in section 3 suggest: (1) that for the entire
sample, the average security price revaluation in the second-quarter
over the estimation period, the predisclosure period, and in the other
weeks in the report period. In this regard, the results presented in this
study are consistent with prior empirical findings of Beaver [1968] and
May [1971]; and (2) that the degree of a security's price revaluation in
response to its second-quarter earnings report is inversely related to the
capitalized value of the firm, other things being equal. This phenomenon
is attributed to differential levels of (private) predisclosure information
production and dissemination on firms of different capitalized values.
A basic implication of the results is that future empirical research
designs requiring control for (private) predisclosure information should
control for the capitalized value of sampled firms. This is particularly
important for studies aimed at testing the "economic consequence" and
/or "effectiveness" of new public information disclosure rules. For example, a finding of no effect at the time a new public disclosure is made
is consistent with several hypotheses, only one of which is that the new
capital asset prices. It may be that the new disclosures have information
content for some firms (lower capitalized values) but not others.
As a final comment, theoretical and empirical research about finer
partitions of firm-specific characteristics that are systematically related
to predisclosure information as well as the economic circumstance(s)
that give rise to such cross-sectional correlation(s) would appear to be
fruitful avenues to pursue in the future.
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