Comparison with the Average: Reference Points and Market Reactions to Above-Average Earnings Surprises

• In Event: Market reaction to earnings
  In Paper Session: Market Reaction to Earnings

Abstract

We examine whether investors use the average earnings surprise of concurrent earnings announcers as a reference point. We find that in the short window surrounding an earnings announcement, the market rewards firms that announce above-average earnings surprises with a premium, consistent with the average being used by investors to classify a firm’s earnings as a gain or a loss. The price premium awarded for an above-average earnings surprise is larger when more earnings announcements are made on the same day, when investors face more uncertainty in assessing firms’ performance and when firms are owned mainly by individual investors. We interpret this evidence as suggesting that investors rely more on the average as a reference point when they are more likely to be subject to cognitive constraints in processing information. Complementing evidence of the price reaction to above-average earnings surprises, we find that firms announcing above-average earnings surprises exhibit a greater abnormal trading volume. This is consistent with the notion that beating reference points encourages investors to trade.

Authors

• Wen He, UNSW Australia

• Yan Li, National University of Singapore