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Market Reactions to Warnings of Negative Earnings Surprises: Further Evidence

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  • Weihong Xu

Abstract

This study examines two plausible explanations for Kasznik and Lev's (1995) counterintuitive finding that warning firms are subject to more negative market returns than no‐warning firms. Namely, are the more negative market reactions to warning firms due to their poorer future earnings performance or due to investor overreaction? I find that, compared with no‐warning firms, warning firms experience more severe one‐year‐ahead earnings declines and these earnings declines can explain the stronger market returns to warning firms. However, my results do not support an investor overreaction explanation. The tests of subsequent abnormal returns of warning firms over various windows do not detect stock return reversals due to correction for overreaction. In addition, the greater revisions in analysts' forecasts for warning firms are found to enhance analyst accuracy rather than increase analyst pessimism. Collectively, my results suggest that the more negative market reactions to warning firms reflect investors' rational anticipation of more severe declines in future earnings for warning firms rather than investor overreaction.

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  • Weihong Xu, 2008. "Market Reactions to Warnings of Negative Earnings Surprises: Further Evidence," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 35(7‐8), pages 818-836, September.
    • Handle: RePEc:bla:jbfnac:v:35:y:2008:i:7-8:p:818-836
    DOI: 10.1111/j.1468-5957.2008.02096.x
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    3. Cox, Raymond A.K. & Dayanandan, Ajit & Donker, Han, 2016. "The Ricochet Effect of Bad News," The International Journal of Accounting, Elsevier, vol. 51(3), pages 385-401.
    4. Dayanandan, Ajit & Donker, Han & Karahan, Gökhan, 2017. "Do voluntary disclosures of bad news improve liquidity?," The North American Journal of Economics and Finance, Elsevier, vol. 40(C), pages 16-29.

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