Earnings response coefficient: Applying individual and portfolio methods

Abstract

This paper reports new findings from applying portfolio method, which shows a much bigger earnings impact on share prices (ERC) compared to the erstwhile reports of ERC using individual events, averaged over the sample. We estimate cumulative abnormal returns, CAR, across a test window for each quarterly earnings announcement event across one accounting year. The CARs are then regressed against earnings changes of individual firms and portfolios. The findings show a significant positive CAR when earnings increases; and a negative CAR if earnings declines. The ERC is very small in the test period of 2001-14, which is consistent with published results for years before 2000. The ERC size magnifies substantially due to the grouping effect used through portfolio formation. What is significant is that the use of portfolio method, by removing the idiosyncratic errors, show a price response very close to the size of earnings. The last evidence supports strongly the value relevance accounting theory that has not seen much support from averaging the price responses of individual event responses.

Determinants of Earnings Response Coefficient in the Nigerian Post-IFRS Implementation Era

“…Investors' reaction to the earnings announcement has recently found out that investors become more active during the earnings announcement period, placing a discount on optimistic earnings forecasts. Al-Baidhani, Abdullah, Ariff, Cheng and Karbhari Y [4] found that investors become more active during the earnings announcement period, placing a discount on optimistic earnings forecasts. Stock price changes and response at the time of prediction presentations depends on the type of predictions and adjustments which is exposed by the management during the fiscal year to fulfill the investors' expectations [5].…”

The Effect of Leverage, Firm Size, Earning Growth, and Earning Persistence on Earning Response Coefficient

“…CAR is obtained from the accumulated abnormal return of each company in the event window, namely 2015 to 2019. This approach is called the association method study which is used to measure the relationship of accounting information to stock prices over a relatively long period, usually one year or more (Collins & Kothari, 1989) and (Al-Baidhani et al, 2017). CAR is calculated by the following formula.…”

Impact of Sovereign Credit Rating Disclosure on Chinese Financial Market

“…McLean et al (2012) advise investors to promote reliable information regarding share prices and reduce financial barriers through dynamic investment based on SCR information. Similarly, accounting information is useful to financial accounting, standard-setting bodies, and equity investors (Al-Baidhani, 2018; Al-Baidhani et al, 2017).…”