The Information Content of

Annual Earning
Announcements
William H. Beaver

Journal of Accounting Research (1968)

Contents

1.

Motivation

2.

Research Question and Conclusion

3.

Sample and Data

4.

Empirical Test

5.

Empirical Result

6.

Contribution and Suggestion

7.

Expansion of Research

Section 1. Motivation

Motivation
Valuation
theory
a relationship
between
earnings and the
value of
common stock

Miller and Modigliani(1954-57)

the value of common stock = f(earning x earnings multiplier for that risk class, )
Empirical evidence: If reported earnings are adjusted for measurement errors
through the use of instrumental variables, the adjusted earnings are useful in the
prediction of the market value of electric utility firms
The earnings term is the most important explanatory variable in valuation
equation

Earnings lack
informational
value

Measurement errors in earnings are so large

Other sources available to investors that contain essentially the same information
but are more timely
Earnings reports have little or no information content

Motivation

To provide empirical evidence to ascertain whether accounting numbers

contained or conveyed information about a firms financial performance
2/13

Section 2. Research Question and Conclusion

Research Question and Conclusion

Does common stock investors perceive earnings to
possess informational value ?
Definition. of Information

Change in expectations
about the outcome of an
event
Sufficiently large change
to induce a change
in the decision-makers
behavior

A firms earnings report is informative (Information content)

If it leads to a change in investors assessments of the

probability distribution of future returns (or price)
Change in equilibrium value of the market price
If it leads to an altering of the optimal holding of that firms
stock in the portfolios of individual investors
Shift in portfolio position would be reflected in the volume

Expectations of individual investors and the market as a whole

are altered by the earnings report
Earnings reports possess information content
3/13

Section 2. Research
Question

Primary Research method

Analyze investor reaction to earnings announcement,

as reflected in the volume and price movements of
common stocks in the weeks surrounding the announcement
date
Earnings
announcement

Different
interpretation
among investors

Increasing
volume before a
consensus is
reached

Lack of
consensus
regarding the
price

Volume
test
Changes in the
expectations of
individual investors
4/13

Change in
equilibrium
value

If risk
preferences
differ, volume
reaction

Price
test
Changes in the
expectations of the
market as a whole

Section 3. Sample and

Data

Sample and Data

Sample and Data Collection
Sample period: 1961~1965
1. Firm on Compustat tape
2. New York Stock Exchange firms
3. Non-12/31 firms
4. No dividend announcement in the same week as
the
earning announcements
5. No stock splits announcement during the 17
week

period surrounding the earning

announcements
6. Less than 20 news announcements per
year appearing in the WSJ
143 firms
506 annual earnings announcements
5/13

Section 4. Empirical
Test

Volume Analysis-Unadjusted for Market Influence

Results

Hypothesis
If earning reports convey information in the sense
of leading to changes in the optimal portfolio
positions, the number of shares traded should be
higher in week 0 than during nonreport period.
Analysis method

Vjt = Computed for each week t in the report period for each
of the 506 earning announcement j

Earnings reports have information content

6/13

Section 4. Empirical
Test

Volume Analysis-Adjusted for Market Influence

Results

Hypothesis
If earning reports convey information in the sense
of leading to changes in the optimal portfolio
positions, the number of shares traded should be
higher in week 0 than during nonreport period.
Analysis method

Nonreport
period

Report
period

Earnings reports have information content

7/13

Section 4. Empirical
Test

Price Analysis-Adjusted for Market Influence

Hypothesis

If earning reports convey information in the sense of leading to changes in the equilibrium
value of the current market price, the magnitude of the price change(without respect to
sign) should be larger in week 0 than during nonreport period.
Analysis method
uit = portion of the individual securitys
firm-specific price change

Nonreport
period

u2 it

= the square of residual (to

eliminate the effect of the signal of
residual)

si2 = mean of u2 it during the nonreport

period (= Var(u2it ))

Report
period

8/13

Section 4. Empirical
Test

Price Analysis-Adjusted for Market Influence, continued

Results

Earnings reports have information content

9/13

Section 5. Empirical
Result

Empirical Result
Analysis

The information contents of

annual earnings announcements

Empirical Results

Volume
(unadjusted)
The largest increase in volume
in the announcement week

Volume
(adjusted)
3

Price
(adjusted)

The largest change in price in

the announcement week

Not only are expectations of

individual investors altered by
earnings report,

But also the expectations of the

market as a whole.

10/13

Section 5. Empirical
Result

Relationship between the Volume and the Price Findings

The issue

How much of the increase price activity can be attributed merely to the fact that
there is more action in the security, rather than to changes in equilibrium prices?

Price changes = sum of price

the market price, whether or not they engage in

changes on each transaction

a purchase or a sale

The variance of the weekly price change will

The total number of transactions, explicit

increase in direct to proportion to the number

and implicit, are the same per time period

of transactions that occur during the time

period
Changes in _price
activity (Ut)
= 1.67

The expectations of the all investors influence

_
More action (et ) = 1.3

Changes
in _price activity

Changes in
equilibrium prices =
0.37

(Ut)

_
More action (et ) = 0
Changes in equilibrium
prices = 1.67

= 1.67

Additional empirical research is needed before this issue will be resolved.

11/13

Section 6. Contribution and

Suggestion

Contribution
Prior Research

This Research

To use stock prices as an dependent

To use trading volumes as well as stock

prices as an dependent variable to

variable to evaluate the usefulness of

evaluate the usefulness of reported

reported earnings

earnings

12/13

Volume test

Price test

Changes in the
expectations of
individual investors

Changes in the
expectations of the
market as a whole

Section 6. Contribution and

Suggestion

Suggestions for Future Research

Suggestions
1

Expectation model

Other types of news

announcements

Normative issue

To explore the possibility of constructing expectations models

that will permit a prediction of the direction and magnitude of
the price residual
Ball and Brown(1968), Beaver-Clark-Wright(1979)
To apply this methodology to other types of news
announcements
Green and Segall: interim earnings reports
Dividend announcements
Should decision makers perceive earnings reports to possess
information value?
To select an event of interest to decision makers and to
investigate the ability of earnings data to predict that event

13/13

Section 6. Expansion of Research

Expansion of Research

May (1971)

Morse (1981)

Atiase (1985)

4.2% vs 115.9%

HagermanZmijewski-Shah(1984)

3 unexpected
earning
unexpected earning
(good news/bad news)

13/13