In-Sync or Out-of-Sync? The Joint Information in Revenues and Expenses

Abstract

When revenues are higher or lower than expected, expenses are normally also higher or lower than expected, but by a smaller amount. We hypothesize that when revenue and expense surprises follow this normal revenue-cost structure (i.e., are "in-sync"), the resultant earnings surprises are more persistent. Conversely, when revenue and expense surprise deviate from the normal cost structure (i.e., are "out-of-sync"), earnings surprise are less persistent. Our findings are consistent with this hypothesis. Further, we show that analysts incorporate into their forecast revisions only some, but not all, of the differential persistence between in-sync and out-of sync earnings surprises. The market also only partially incorporates this differential persistence into stock prices, leading to differential post-earnings-announcement-drifts for in-sync and out-of-sync earnings surprises. In comparison with prior research findings, we show that revenue and expense surprises are more informative about future earnings when considered jointly rather than as separate variables. In particular, once we account for the joint information in revenue and expense surprises, the incremental information of revenue surprises per se over earnings surprises documented by prior research is substantially weakened or eliminated.

Keywords: Revenue surprises, expense surprises, earnings persistence, analyst forecasts, post-earnings-announcement-drift

JEL Classification: M41, G14, G29