Rest in Peace Post-Earnings Announcement Drift

This paper revisits price formation following earnings announcements. In modern financial markets, stock prices fully reflect earnings surprises on the announcement date, leading to the disappearance of post-earnings announcement drifts (PEAD). For large stocks, PEAD have been non-existent since 2006 but has only disappeared recently for microcap stocks. PEAD remain a prevalent area of study in finance and accounting despite having largely disappeared. This paper concludes with a set of recommendations for researchers who conduct such studies to better assess the existence of PEAD and suggests future research avenues to examine price formation following earnings news.

AGGREGATE EARNINGS AND RETURNS IN BRAZIL

We used the method employed in Kothari, Lewellen and Warner (2006) to show the relationship between aggregate earnings and market returns in Brazil in the period from 1995 to 2017. Considering the findings found by Kothari, Lewellen and Warnet (2006), our results indicate that the theory of Bernard and Thomas (1990) is more consistent with the US market than with the Brazilian market, signaling that the aggregate post-earnings announcement drift tends to be larger in markets with higher earnings persistence, like Brazil. Our findings also indicate that the relationship between aggregate returns and earnings in Brazil tends to be positive for the current period and the next two quarters, corroborating the Sadka and Sadka (2009) study. Considering that the predictability of earnings in the US market is higher than that in Brazil, our results also support the argument by He and Hu (2014) that the relationship between aggregate earnings and returns is linked to each country’s level of disclosure. However, new evidences reveal the influence of high interest rates on financial market results, suggesting that expectations of increased interest rates tend to reduce aggregate current returns in Brazil due to the possible migration of capital to lower risk, given the attractiveness of their returns in an environment of high inflation.

Factor momentum, option-implied volatility scaling, and investor sentiment

Factor momentum produces robust average returns that exhibit a similar economic magnitude as stock price momentum. To the extent that the post-earnings announcement drift (PEAD) factor captures mispricing, winner factors earn profits from being long on underpriced stocks and short on overpriced stocks. Conversely, loser-factors’ negative exposure to the PEAD factor suggests that loser factors capture mispricing by being long on overpriced stocks and short on underpriced stocks. Option-implied volatility scaling increases both the economic magnitude and statistical significance of factor momentum. Factor momentum is not exposed to the same crashes as stock price momentum and therefore could provide a hedge for stock price momentum crash risks. Also, factor momentum mispricing is more pronounced when investor sentiment is high.

Corporate Social Responsibility and Post Earnings Announcement Drift: Evidence from Korea

To promote corporate social responsibility (CSR) in emerging markets such as South Korea to the level of developed nations, support from capital market investors is necessary. That is, CSR activities expand if capital market investors actively invest in companies that pursue such activities. This study thus analyzes the influence of the level of CSR activities on the post-earnings-announcement drift (PEAD) of publicly listed companies in South Korea, given the need to analyze the relationship between capital markets and CSR, which is part of sustainability management strategies. A sample of Korean firms listed on the Korean Stock Exchange from 2014 to 2018 was used for the regression analysis. The financial and stock return data were extracted from the KIS-Value database and CSR activities data were collected from the Korea Economic Justice Institute (KEJI) Index. The empirical analysis determined that more inactive companies in terms of CSR exhibited greater PEAD magnitude. Furthermore, high information asymmetry was found to further increase the magnitude of PEAD. These results indicate that investors cannot make swift investment decisions because of their low confidence in the information disclosed by inactive CSR companies; as a result, earnings information is slowly reflected in the stock prices of the period following disclosure. These findings suggest that CSR plays an important role in boosting investor confidence in corporate earnings information.