Earnings announcements and stock market returns

162 Pages·2017·4.83 MB·English

Jasmina Saldic and Julie Vinæs
________________________________

Earnings announcements and stock
market returns
An event study of the Nordic market

Masteroppgave i økonomi og administrasjon
Handelshøyskolen ved HiOA
2017
Abstract

We have examined the effects of quarterly earnings announcements on stock returns, in the
Nordic market. Our main objective, is to test market efficiency using the event study
methodology. Earlier research has found evidence of drift in stock return, following earnings
announcements. We therefore examine both the pre- and post-announcement period.
Three different time-series models are used to capture the earnings surprise. The earnings
are categorized into three categories; good news, bad news and no news. Our results show
that the Nordic market reacts quickly to earnings announcement, and that earnings have
information value. However, we find significant post-announcement drift for good news in
the aggregated Nordic market, and for companies with low market capitalization. We also
find significant reactions before the announcement of good news, both for the aggregated
Nordic market and for each country, except Denmark.

Sammendrag

Vi har undersøkt effektene av kvartalsvise resultatkunngjøringer på aksjeavkastninger, i det
nordiske markedet. Vi tester markedseffisiens ved å bruke event-studie metodologi.
Tidligere forskning har funnet bevis for drift i aksjeavkastninger, som følge av
resultatkunngjøringer. Vi undersøker derfor både perioden før og etter annonseringen. Tre
forskjellige tidsseriemodeller brukes til å fange opp den uventede resultatkunngjøringen.
Resultatkunngjøringene er delt opp i tre kategorier; gode- , dårlige- og ingen nyheter. Våre
resultater viser at det nordiske markedet reagerer raskt på resultatkunngjøringer, og at
resultatkunngjøringer har informasjonsverdi. Vi finner signifikant PEAD for gode nyheter på
det aggregerte nordiske markedet, og for selskaper med lav markedsverdi. Vi finner også
signifikante reaksjoner før annonseringen av gode nyheter, både for det aggregerte nordiske
markedet og for hvert enkelt land, unntatt Danmark.

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Preface

This thesis is written as a final part of the Master´s Programme in Business Administration at
Oslo and Akershus University College of Applied Sciences, in the field of Financial
Economics.

The motivation for writing this thesis comes from a fascination with the efficient market
hypothesis, and how using large amounts of data makes it possible to analyze the reaction of
different market participants. We are especially interested in the relationship between
finance and accounting, and the announcement of earnings gives the opportunity to examine
how the market reacts to this information. The handling and analyzing of our data has been a
challenging process. However, it has been a very educational and interesting experience.

We would like to thank our supervisor Muhammad Azeem Qureshi for his contribution and
feedback during the process. We would also like to thank Andreea Ioana Alecu for valuable
help with programming and analyzing data in R.

Oslo, May 2017.

Jasmina Saldic and Julie Vinæs

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Content

1 INTRODUCTION AND RESEARCH QUESTION ............................................................................ 7
1.1 RESEARCH QUESTION .................................................................................................................. 9
2 LITERATURE REVIEW AND BACKGROUND .............................................................................. 11
2.1 INTRODUCTION ........................................................................................................................ 11
2.2 INFORMATION CONTENT AND VALUE RELEVANCE OF EARNINGS ......................................................... 12
2.2.1 Global research ................................................................................................................ 12
2.2.2 Nordic Research ............................................................................................................... 14
2.3 EFFICIENT MARKETS .................................................................................................................. 15
2.3.1 The efficient market hypothesis ....................................................................................... 15
2.3.2 Market anomalies ............................................................................................................ 16
2.3.3 Behavioral finance and inefficient markets ..................................................................... 18
2.4 POST EARNINGS ANNOUNCEMENT DRIFT (PEAD) ........................................................................... 19
2.4.1 Explanations of post-earnings announcement drift ......................................................... 20
3 DATA ..................................................................................................................................... 23
3.1 THE NORDIC MARKET ............................................................................................................... 23
3.2 DATA COLLECTION AND SELECTION .............................................................................................. 25
3.3 DEFINITION OF THE ANNOUNCEMENT (EVENT) DATE ....................................................................... 28
4 EMPIRICAL METHOD ............................................................................................................. 29
4.1 EXPECTATIONS OF EARNINGS ...................................................................................................... 29
4.1.1 Analyst forecast vs time series models ............................................................................ 29
4.1.2 Time-series properties of earnings ................................................................................... 30
4.2 EARNINGS SURPRISE .................................................................................................................. 32
4.3 EVENT STUDY ........................................................................................................................... 34
4.3.1 Long- and short horizon event studies ............................................................................. 34
4.3.2 Models for normal return ................................................................................................ 36
4.3.3 Estimating the market model .......................................................................................... 40
4.3.4 Aggregating abnormal return .......................................................................................... 41
4.3.5 Significance tests ............................................................................................................. 42
5 ANALYSIS AND RESULTS ........................................................................................................ 47
5.1 LIMITATIONS AND MODEL CHOICE ............................................................................................... 47
5.2 RESULTS FROM THE NORDIC MARKET ........................................................................................... 48
5.3 RESULTS FROM EACH INDIVIDUAL COUNTRY ................................................................................... 52
5.3.1 Denmark .......................................................................................................................... 52
5.3.2 Finland ............................................................................................................................. 55
5.3.3 Norway ............................................................................................................................ 58
5.3.4 Sweden ............................................................................................................................ 61
5.3.5 Summary of country results ............................................................................................. 65
5.4 INDUSTRIES ............................................................................................................................. 66
5.4.1 CAAR plots for each industry ........................................................................................... 67
5.4.2 Summary of industry results ............................................................................................ 72
5.5 MARKET CAPITALIZATION ........................................................................................................... 73
5.6 TURNOVER BY VALUE ................................................................................................................ 75
6 CONCLUSION ......................................................................................................................... 78
REFERENCES .................................................................................................................................. 80
APPENDIX ...................................................................................................................................... 86
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SUMMARY STATISTICS ............................................................................................................................ 86
CORRELATION MATRIX ............................................................................................................................ 88
INDUSTRY CLASSIFICATION BENCHMARK DESCRIPTION ................................................................................. 88
EVENT STUDY RESULTS ............................................................................................................................ 89
LIST OVER COMPANIES IN THE SAMPLE ..................................................................................................... 159

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Figures and tables

TABLE 3.1: INDUSTRY DISTRIBUTION, MARKET CAP AND TURNOVER IN THE FINAL SAMPLE ......................................................... 24
TABLE 3.2: SELECTION CRITERIA FOR EACH COUNTRY ......................................................................................................... 28
TABLE 4.1:OVERVIEW OF OUR EVENT WINDOWS .............................................................................................................. 36
TABLE 5.1: NEWS DISTRIBUTION FOR THE NORDIC MARKET ................................................................................................ 48
TABLE 5.2: CAAR WITH CORRESPONDING T-VALUES FOR THE NORDIC MARKET ...................................................................... 50
TABLE 5.3: DAILY AVERAGE ABNORMAL RETURN FOR THE NORDIC MARKET ........................................................................... 51
TABLE 5.4: NEWS DISTRIBUTION FOR THE DANISH MARKET ................................................................................................ 52
TABLE 5.5: CAAR WITH CORRESPONDING T-VALUES FOR THE DANISH MARKET ...................................................................... 54
TABLE 5.6: DAILY AVERAGE ABNORMAL RETURN FOR THE DANISH MARKET ............................................................................ 55
TABLE 5.7: NEWS DISTRIBUTION FOR THE FINNISH MARKET ................................................................................................ 55
TABLE 5.8: CAAR WITH CORRESPONDING T-VALUES FOR THE FINNISH MARKET ...................................................................... 57
TABLE 5.9: DAILY AVERAGE ABNORMAL RETURN FOR THE FINNISH MARKET ........................................................................... 58
TABLE 5.10: NEWS DISTRIBUTION FOR THE NORWEGIAN MARKET ....................................................................................... 58
TABLE 5.11: CAAR WITH CORRESPONDING T-VALUES FOR THE NORWEGIAN MARKET ............................................................. 60
TABLE 5.12: DAILY AVERAGE ABNORMAL RETURN FOR THE NORWEGIAN MARKET ................................................................... 61
TABLE 5.13: NEWS DISTRIBUTION FOR THE SWEDISH MARKET. ........................................................................................... 61
TABLE 5.14: CAAR WITH CORRESPONDING T-VALUES FOR THE SWEDISH MARKET .................................................................. 63
TABLE 5.15: DAILY AVERAGE ABNORMAL RETURN FOR THE SWEDISH MARKET ........................................................................ 64
TABLE 5.16: SUMMARY OF COUNTRY RESULTS ................................................................................................................. 65
TABLE 5.17: NEWS DISTRIBUTION FOR THE INDUSTRIES ..................................................................................................... 66
TABLE 5.18:SUMMARY OF INDUSTRY RESULTS ................................................................................................................. 72
TABLE 5.19: NEWS DISTRIBUTION FOR MARKET CAPITALIZATION ......................................................................................... 73
TABLE 5.20: SUMMARY OF MARKET CAPITALIZATION RESULTS ............................................................................................ 75
TABLE 5.21: NEWS DISTRIBUTION FOR TURNOVER BY VALUE ............................................................................................... 76
TABLE 5.22: SUMMARY OF TURNOVER BY VALUE RESULTS .................................................................................................. 77

FIGURE 1.1: MSCI ALL CAP PRICE INDEX .......................................................................................................................... 9
FIGURE 4.1: ILLUSTRATION OF THE ESTIMATION- AND EVENT WINDOW ................................................................................. 35
FIGURE 5.1: CAAR PLOT FOR THE NORDIC MARKET .......................................................................................................... 49
FIGURE 5.2: CAAR PLOT FOR THE DANISH MARKET .......................................................................................................... 53
FIGURE 5.3: CAAR PLOT FOR THE FINNISH MARKET .......................................................................................................... 56
FIGURE 5.4: CAAR PLOT FOR THE NORWEGIAN MARKET ................................................................................................... 59
FIGURE 5.5: CAAR PLOT FOR THE SWEDISH MARKET ........................................................................................................ 62
FIGURE 5.6: CAAR PLOT FOR BASIC MATERIALS .............................................................................................................. 67
FIGURE 5.7: CAAR PLOT FOR CONSUMER GOODS ............................................................................................................ 68
FIGURE 5.8: CAAR PLOT FOR CONSUMER SERVICES ......................................................................................................... 68
FIGURE 5.9: CAAR PLOT FOR HEALTH CARE .................................................................................................................... 69
FIGURE 5.10: CAAR PLOT FOR INDUSTRIALS ................................................................................................................... 69
FIGURE 5.11: CAAR PLOT FOR OIL & GAS ...................................................................................................................... 70
FIGURE 5.12: CAAR PLOT FOR TECHNOLOGY .................................................................................................................. 70
FIGURE 5.13: CAAR PLOT FOR TELECOMMUNICATIONS .................................................................................................... 71
FIGURE 5.14: CAAR PLOT FOR UTILITIES ........................................................................................................................ 71
FIGURE 5.15: CAAR PLOT FOR MARKET CAPITALIZATION ................................................................................................... 74
FIGURE 5.16: CAAR PLOT FOR TURNOVER BY VALUE ........................................................................................................ 76

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1 Introduction and Research Question

“A market in which prices always “fully reflect” available information is called “efficient””
(Fama 1970, 383)

Market efficiency is one of the fundamental assumptions, regarding the valuation of a stock
market. A well-functioning capital market is essential for a reliable valuation of the market,
and for the allocation of recourses. In efficient markets, the price reflects all information that
is available to the market participants. When new information is introduced to the market, the
price changes instantly. Many papers over the past 70 years have been focused on this theme,
both advocating it and contradicting it. One way to test market efficiency, is by examining
stock market reactions to earnings announcements. Other announcements like mergers, stock
splits and dividends, can also be used to test market efficiency.

In this master thesis, we will examine stock market reactions to earnings announcements. We
use the event study methodology to examine market efficiency in the Nordic market.
Anomalies are potential contradictions to the efficient market hypothesis. One of the most
lasting and debated anomaly, is the post-earnings announcement drift (PEAD). If the market
is efficient, there should not be a consistent systematic abnormal return in the time after the
event. “Post-earnings announcement drift is the tendency for a stock´s cumulative abnormal
returns to drift in the direction of an earnings surprise for several weeks following an earnings
announcement” (Livnat and Mendenhall 2006). If anomalies such as the PEAD effect exists,
it could be exploited using a trading strategy to earn an abnormal return.

Most of the studies on market efficiency, earnings announcements and the PEAD, are based
on the US market. Our sample for this master thesis, is the Nordic market. Earlier studies on
the Nordic market have focused on individual countries. Lessard (1974) examined the
international structure of returns, and pointed out that there is a low correlation between
national markets. We therefore find it interesting to examine both the different countries and
the aggregated market. To our knowledge, there are no studies examining both the aggregated
Nordic market, and potential differences between the countries with regards to earnings
announcements. Our thesis therefore provides research on a new market, and reflects a more
recent time period.
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Nordic market consists of the countries Denmark, Finland, Iceland, Norway and Sweden. The
countries have many similarities both in the legal structure, government, business
environment and resources. Cavaglia, Brightman, and Aked (2000) examined the importance
of country factors and industry factors, for security returns in the period from 1986 until 1999.
Their findings show that industry factors are increasing in importance, and might dominate
country factors. This could indicate that the industry structure within a country, might be an
explanation for country differences. In the Nordic market the industry structure differs. We
will therefore examine potential differences between industries, with regards to earnings
announcements. The companies in the Nordic market, also differ with regards to company
size and liquidity. In addition to the industry factor, we will therefore also examine how
companies with different size and liquidity react to earnings announcements.

Our sample period is from first quarter 2011 until fourth quarter 2015. During this period, the
stock market in the individual Nordic countries, evolved differently. This is illustrated by the
All-Share Indexes in Figure 1.1. For instance, in Denmark, the average yearly return in our
sample period was 15,10%, while the average yearly return in Norway was -4,38%, with
average yearly standard deviation of 17,00% and 21,78%, respectively. This could give the
opportunity to examine the announcement of earnings under different market conditions, in
comparable countries.

The graph in figure 1.1, shows the price development in the different countries between 2008-
2016, represented by the MSCI All Cap Price Index.
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Figure 1.1: MSCI All Cap Price Index

1.1 Research Question

Our main research question is:
• Does the stock return react efficiently to the announcement of quarterly earnings?

Other sub questions to answer our main research question are:
• Does the Nordic market experience post-earnings announcement drift?
• Are there any differences between the countries in the Nordic market, regarding
market efficiency and post-earnings announcement drift?

Our thesis is divided into 6 sections. Section 2 contains a review of earlier research on the
information content of earnings announcements, efficient markets, anomalies and opposing
theories to efficient markets. The assumption that earnings announcements have news value
to capital markets, is essential when testing market efficiency. Earlier studies have provided
evidence regarding the information content of earnings announcements. Quarterly earnings
per share (EPS), as we use in our thesis, are considered to have news value when they are
unexpected by the market participants.
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In section 3, we will present our sample data, collection and selection criteria. We have
imposed different criteria on our dataset and the opportunity to generalize our results might be
limited. Our sample only includes non-financial companies with a history of at least 8 years.
Our methodology is presented in section 4. In this section, we will review earlier research on
both time series properties of earnings, different expectation models and the event study
methodology. Section 5 and Section 6 contains our analysis and conclusion.

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