Winning Is Not Enough: Changing Landscapes of Earnings Surprises and the Market Reaction

59 Pages Posted: 26 May 2021 Last revised: 27 Jan 2023

See all articles by John C. Heater

John C. Heater

Duke University - Fuqua School of Business

Ye Liu

Fudan University

Qin Tan

City University of Hong Kong (CityU)

Frank Zhang

Yale School of Management

Date Written: January 26, 2023

Abstract

In this paper, we document strikingly opposite time-series patterns of earnings surprises and associated market reactions. Earnings surprises have increased over time, with the mean analyst forecast error (FE) rising from negative 1 to 2 cents in the 1990s to positive 1 to 2 cents in the 2010s, whereas average earnings announcement returns have declined from 0.30% in the 1990s to -0.30% in the 2010s, turning negative in the past 17 years. Underlying the time-series pattern of increasing FEs is a secular trend where firms move away from just meet or small beat, to which the market reaction has become increasingly negative, towards a large beat, whereas the frequency of meeting or beating consensus analyst forecasts remains stable during the same period. We develop a parsimonious predictive model of FEs based on peer and past analysts’ forecast errors, and find that our predicted FE closely mirrors reported FE, with the average value hovering around 1 to 2 cents in most years of the past two decades. The market reaction to “around-zero” unexpected FE (FE minus predicted FE) is indistinguishable from zero over time, suggesting that our model serves as a good benchmark of the market expectation. Our evidence has broad implications for appropriate earnings benchmarking, for a disappearing discontinuity in the earnings surprise distribution around zero, for empirical designs when examining the earnings-return relation, and for a disappearing earnings announcement premium.

Keywords: Analyst forecast, earnings surprises, earnings announcement returns, capital markets, discontinuity

JEL Classification: G30, G32, M21, M41

Suggested Citation

Heater, John C. and Liu, Ye and Tan, Qin and Zhang, Frank, Winning Is Not Enough: Changing Landscapes of Earnings Surprises and the Market Reaction (January 26, 2023). Available at SSRN: https://ssrn.com/abstract=3853030 or http://dx.doi.org/10.2139/ssrn.3853030

John C. Heater

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-1085 (Phone)

HOME PAGE: http://www.johnheater.com

Ye Liu

Fudan University ( email )

670 Guoshun Rd
Shanghai, Shanghai 200433
China

Qin Tan

City University of Hong Kong (CityU) ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong

Frank Zhang (Contact Author)

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

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