The Effect of Earnings Disclosures on Stock Prices in Developed Economies

Abstract

This study aims to evaluate the usefulness and relevance of accounting earnings disclosures, as the key determinant for share price changes. The main objective is to examine whether earnings response coefficient (ERC) behavior could explain more fully the share price changes, as to the reason why the share price change is not equal to the amount of announced earnings. The study is done with data sets from four developed countries of the Organization for Economic Co-operation and Development (OECD) group (i.e., Japan, the United Kingdom (UK), Sweden, and Switzerland) for the period 2001-2014. 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 out of all observations sorted by size of earnings into ten portfolios for each country. The portfolio method used was aimed at controlling possible idiosyncratic-errors-in-variables problem using individual event measures. The results using individual-event measures resulted in reasonable ERC sizes with high R2 explanatory power, a little higher than those reported in prior studies on other countries. Importantly, portfolio-based ERCs are close to the magnitude of the earnings in some tests, which supports the famous value relevance theory in accounting. This finding is new to this literature.

Keywords: Earnings Announcements/Disclosures, Share/Stock Price, Earnings Response Coefficient, Developed Economies, Japan, UK, Sweden, Switzerland, Earnings Relevance, Portfolio Method

JEL Classification: G12, G14 & G21