Post-Earnings Announcement Reversal: The Puzzling Case of Seasonal Random Walk Firms

• In Event: Market Reactions to Earnings

Abstract

Prior literature suggests that the market underreacts to the commonly observed positive correlation in firms’ seasonal earnings changes, which leads to a post-earnings-announcement-drift (PEAD) in stock prices. We examine the market reaction for a distinct set of firms whose seasonal changes in quarterly earnings are uncorrelated. We document that the market acts as if the seasonal earnings changes of these firms are in fact correlated, consistent with an overreaction. We also show that positive (negative) seasonal earnings changes in the current quarter are associated with negative (positive) abnormal returns in the following quarter. Thus, as opposed to the typical PEAD, we observe a reversal of abnormal returns. Additional analysis indicates that these results are driven primarily by firms with relatively poor information environments. We similarly find that financial analysts overestimate the autocorrelation of these firms, though to a lesser extent. Our results provide a unique perspective on the inability of prices to fully reflect the implications of current earnings for future earnings.

Authors

• Allen W Bathke Jr, Florida State University

• Terry Mason, Florida State University

• Richard M Morton, Florida State University