Under-or-overreaction: Market responses to announcements of earnings surprises |
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| Institution: | 1. Alfaisal University, P.O. Box 50927, Riyadh 11533, Saudi Arabia;2. University of Louisville, Louisville, KY 40292, USA;1. College of Business, University of South Florida, 4202 E. Fowler Avenue, BSN 3403, Tampa, FL 33620, United States;2. Sykes College of Business, University of Tampa, 401 W. Kennedy Blvd., Tampa, FL 33606, United States;1. Division of Management, Hansung University, Seoul, Republic of Korea;2. School of Business, Yonsei University, 50 Yonsei-ro, Seodaemun-gu, Seoul, Republic of Korea;3. KDI School of Public Policy and Management, Seoul, Republic of Korea |
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| Abstract: | We test whether the well-documented market reaction to the announcements of earnings surprises is a manifestation of an investor underreaction or overreaction to extremely good or bad earnings news. Using the market reaction in the three-day period surrounding the announcements of extreme earnings surprises (i.e., SUE) in quarter Qt as a reference point, we show that firms reporting a high (low) SUE in subsequent quarter Qt + 1 that confirms their initial quarter Qt SUE ranking in the same highest or lowest SUE quintiles generate an incremental price run that moves in the same direction as that of the initial SUE. However, the price impact of the confirming SUE signal is weaker than that of its initial SUE. Our findings are robust to the Fama-French three-factor daily regression extended by the momentum factor and a number of other robustness tests. Our result is not consistent with the prevalent view that investors underreact to earnings news. To the contrary, the evidence suggests an initial investor overreaction to extreme SUE signals. |
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