Stock Price Response to Earnings Announcements in a Major Emerging Economy

Abstract

The aim of this study is to evaluate the relevance and usefulness of accounting information, specifically earnings announcements, as the key determinant for stock price changes. The main objective is to investigate whether ERC behavior could explain more fully the stock price changes, as to the reason why the stock price change is not equal to the amount of announced earnings. The study reports significant findings from applying portfolio method, which shows major stock price reactions and very large earnings response coefficients to accounting earnings disclosed to the stock exchange markets of Mexico as a major emerging economy, for the period 2001-2014. The abnormal returns to disclosed events are significantly positive when earnings increase and negative when earnings decrease. Two measures of abnormal returns are regressed against the size of the announced earnings. The first regression uses measures from individual events. The second regression uses a new measure; that is, from portfolios made of all observations sorted by size of earnings into ten portfolios. The portfolio method used was aimed at controlling possible idiosyncratic-errors-in-variables problem using individual event measures. The findings using individual-event measures resulted in reasonable-size earnings response coefficient with high R2 explanatory power, a little higher than those reported in prior studies on other countries. Meanwhile, the portfolio method led to a much bigger size of earnings response coefficient that strongly support the value relevance accounting theory. This finding is new to this literature.

Keywords: Earnings Announcements, Stock Price, Earnings Response Coefficient, Emerging Economy, Mexico, Earnings Relevance, Portfolio Method

JEL Classification: G12, G14 & G21