An Empirical Investigation of the Adjustment of Stock Prices to New Quarterly Earnings Information

The use of residuals, both mean and mean absolute, was found to be useful in capturing the impact of new quarterly earnings information on share prices. Our results seem to indicate that the market evaluates third quarter and annual earnings reports differentially from the first and second reports. This can perhaps be explained in part because the annual report, which is audited, contains year-end accounting adjustments. Furthermore, the third quarter report may be viewed as a harbinger of the annual report. Our results also indicate that the share prices of high growth companies adjust to earnings information differently than do the shares of medium and low growth firms. In total our results seem to be consistent with the “loose” form of the efficient markets hypothesis. This is because of the difficulty in predicting the signs of the mean residuals. Or alternatively, while we could observe significant changes in the absolute means, it was considerably more difficult to predict the direction of these changes as seen in the mean residuals. While the difficulty of predicting the direction of the residuals and the loss of statistical significance between trading days when days −1 and 0 in the group tests over all reports indicate support of market efficiency, it should be reemphasized that the market appears to take very long to react to the annual report — that is, the reaction seems to start even before the third quarter report.