Another important domain of application for the event study methodology (ESM) is the research of stock market response to earnings announcements to verify whether or not they possess informational value. The work of Anderson (2007) uses the ESMto determine if a dividend signal can be identified, given that earnings and dividends are jointly made public. The ESM is also helpful in testing the efficient market theory, by investigating the announcements impact on stock prices’ risks adjusted rate of return, as illustrated in the paper of Jones (2007).
There is a large body of works that examine cross-country differences in terms of stock returns and accounting earnings connections based on event studies, but most of them cannot determine whether or not investors actually use the information to price securities. Thus, in contrast to earlier papers, researchers have moved on and developed analyses that emphasize investors’ reactions to earnings announcements and identify the influencing elements responsible for the different content of such announcements (for example, the study of DeFond et al., 2005). Most findings indicate that structural factors in the financial reporting explain these differences, and earnings announcements are more informative in countries with strong investor protection and a better earnings quality. The event study application generally illustrates a high correlation between positive stock returns and over-expectation earnings figures, and also between negative stock returns and worse than expected earnings value.
References and further readings
Anderson, W. 2007. 'Dividend signals in the context of joint dividend and earnings'. University of Canterbury Working Paper, New Zealand.
DeFond, M., Hung, M. and Trezevant, R. 2005. 'Investor protection and the information content of annual earnings announcements: International evidence'. Leventhal School of Business Working Paper.
Henry, E. 2008. 'Are investors influenced by how earnings press releases are written?'. Journal of Business Communication, 45(4): 363-407.
Jones, N. 2007. 'Surprise earnings announcement: A test of market efficiency'. Proceedings of Allied Academies International Conference, 12(1): 43-48.
Lenroth, H., Freslund, M. and Thingaard, F. 2003. 'Annual earnings announcements and market reaction: The case of a small capital market'. Working Paper of The Aarhus School of Business, Denmark.