International Diversification, SFAS 131, and Post-Earnings Announcement Drift

Abstract

Using 1990 through 2013 data of U.S. firms with foreign operations, we show that (1) the serial correlation of analyst forecast errors increases to the degree that firms diversify internationally, (2) post-earnings-announcement drift (PEAD) based on analyst forecast errors increases to the degree that firms increase international operations, and (3) international diversification’s impact on the serial correlation of analyst forecast errors and its associated drift is significantly reduced after the implementation of SFAS 131, which requires firms to report disaggregated information of operating segments based on the way management organizes the segments within the enterprise for making operating decisions and assessing performance. When we replicate our tests using seasonally differenced earnings, we fail to observe patterns similar to those using analyst forecast errors. Overall, the results of our study suggest that investors’ underreaction to announced earnings is a likely explanation for PEAD. Our findings also indicate that disclosures required under SFAS 131 are informative in helping analysts more accurately predict earnings, which can help capital markets price internationally diversified firms’ earnings.

Keywords: Post-Earnings-Announcement Drift, International Diversification, Analyst Forecast, Serial Correlation

JEL Classification: G10, G12, G15, G17, G32