The Relevance of ‘Other Surprises’ in Explaining Earnings Announcement Returns

Abstract

Previous research documents two puzzling results that cast doubt on the usefulness of accounting information to investors: the declining power of street EPS in explaining earnings announcement returns and increasing price reactions to earnings announcements. I show this evidence is due to omitting non-street EPS surprises from the earnings announcement analysis. When I control for ‘other surprises’ based on seven I/B/E/S most frequent forecasts: sales, gross margin, EBITDA, operating and net income, GAAP earnings and cash flows, the adjusted R2 increases over fourfold and street EPS lose explanatory power. The ‘other surprises’ are useful on their own and help interpret street EPS surprises, particularly small street EPS surprises, and earnings news of high accrual and growth stocks, and of high institutional ownership firms. Overall, the study identifies an important set of previously omitted variables that investors use in assessing earnings announcement day information.

Keywords: earnings announcements, unexpected news, street EPS surprises

JEL Classification: G12, G17