Implications of Transaction Costs for the Post-Earnings-Announcement Drift
Singapore Management University - School of Accountancy
Tjomme O. Rusticus
London Business School; Northwestern University - Kellogg School of Management
Rodrigo S. Verdi
Massachusetts Institute of Technology (MIT)
Journal of Accounting Research, Vol. 46, No. 3, June 2008
This paper examines the effect of transaction costs on the post-earnings-announcement drift (PEAD). Using standard market microstructure features we show that transaction costs constrain the informed trades that are necessary to incorporate earnings information into price. This leads to weaker return responses at the time of the earnings announcement and higher subsequent returns drift for firms with high transaction costs. Consistent with this prediction, we find that earnings response coefficients are lower for firms with higher transaction costs. Using portfolio analyses, we find that the profits of implementing the PEAD trading strategy are significantly reduced by transaction costs. In addition, we show, using a combination of portfolio and regression analyses, that firms with higher transaction costs are the ones that provide the higher abnormal returns for the PEAD strategy. Our results indicate that transaction costs can provide an explanation not only for the persistence but also for the existence of PEAD.
Keywords: market efficiency, transaction costs, post-earnings-announcement-drift
JEL Classification: G12, G14, M41
Date posted: October 24, 2007 ; Last revised: April 18, 2013
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