AAA Spark Meeting of Regions

Investors’ Reliance on Indicator Consistency at Earnings Announcements: Earnings Persistence or Indicator Precision?

• In Event: Information Content in Earnings Announcements

Abstract

I examine whether the consistency between the earnings surprise and the sales surprise (cash flow surprise) increases the informativeness of sales (cash flow) in valuation. Prior studies show that earnings response coefficients (ERCs) are higher when the earnings surprise is consistent in sign with the sales surprise or the cash flow surprise because the consistency suggests higher earnings persistence. I provide new evidence that indicator consistency increases sales response coefficients and cash flow response coefficients as well as ERCs. This consistency effect for sales and cash flow cannot be explained by the persistence argument from prior studies. I propose a new argument that can explain the consistency effects for all three indicators. I posit that investors perceive consistent indicators to each be more precise and thus rely more on each indicator. Under this precision argument, I predict and show that indicator consistency is particularly useful when there is high uncertainty about indicator precision because indicator consistency can resolve this uncertainty.

Author

• Eunju Lee, Temple University