Using Market Reaction to Infer Persistence of Earnings Surprises

50 Pages Posted: 10 Sep 2007

See all articles by Gia Chevis

Gia Chevis

Baylor University - Hankamer School of Business

Gregory A. Sommers

Southern Methodist University (SMU) - Accounting Department

Date Written: September 10, 2007

Abstract

We measure the market's assessment of the information in a particular earnings surprise by calculating a firm- and time-specific earnings response coefficient (FTERC). We use the FTERC to infer the market's expectation of the persistence of unexpected earnings and also develop an interpretive framework. Examining the market's response to a particular earnings surprise - rather than whether it, on average, over- or underreacts - allows researchers to use the FTERC as a dependent variable (e.g. in a study of disclosure quality) or as a control when each response is unique (e.g. a firm before, during and after fraud). Our model implies seven classifications of expected persistence: growing, permanent, decaying, transitory, partially offsetting, offsetting, and subsuming. We find that approximately 1 in 4 earnings announcements results in an FTERC within the 'normal' permanent-to-transitory range; over 70% of expectation revisions are growing or subsuming.

Keywords: earnings response coefficient, persistence

JEL Classification: M41, G12

Suggested Citation

Chevis, Gia Marie and Sommers, Gregory A., Using Market Reaction to Infer Persistence of Earnings Surprises (September 10, 2007). Available at SSRN: https://ssrn.com/abstract=1013350 or http://dx.doi.org/10.2139/ssrn.1013350

Gia Marie Chevis (Contact Author)

Baylor University - Hankamer School of Business ( email )

One Bear Place #98002
Waco, TX 76798
United States
254-710-1328 (Phone)
254-710-1067 (Fax)

Gregory A. Sommers

Southern Methodist University (SMU) - Accounting Department ( email )

United States
214-768-1188 (Phone)
214-768-4099 (Fax)

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