Do Bright-Line Earnings Surprises Really Affect Stock Price Reactions?
Management Science, Forthcoming
Posted: 13 Apr 2016
Date Written: October 2015
Several influential studies have concluded that earnings surprises just to the right or to the left of a hypothesized bright line produce distinct price reactions compared to the surrounding earnings surprises because they convey special meaning. In this study, we examine whether previous inferences of asymmetric stock price reactions to bright-line surprises are observed when empirical tests are designed to be consistent with a rational expectations equilibrium. Focusing on a small range of earnings surprises around hypothesized bright lines, we find no evidence of asymmetric price reactions once investors’ ex ante expectation of bias in earnings surprises is controlled. Results from additional tests yield support for the external validity of the theoretical framework underlying our bright-line pricing tests. Our findings suggest simple refinements to traditional bins-comparison and regression tests for asymmetric price reactions to bright-line earnings surprises, which account for necessary conditions implied by a rational expectations equilibrium.
Keywords: rational expectations; bright-line; asymmetry; rewards and penalties; meet or beat
JEL Classification: C13, D84, G14
Suggested Citation: Suggested Citation