Corporate Governance, Information Uncertainty and Market Reaction to Information Signals

We examine whether the reaction of investors to earnings announcements is influenced by a firm’s governance profile. We find that firms with better governance characteristics experience a larger initial reaction to both good and bad earnings announcements regardless of the prevailing sentiment and uncertainty conditions. However, the influence of governance is constrained to the announcement period and becomes insignificant during the post-announcement period. In contrast, we demonstrate that changes in market uncertainty and/or investor sentiment are related to the post earnings announcement drift suggesting that investors only return to reconsider their initial reaction to an announcement when there is a change in the conditions that influenced their reaction in the first place. We find that the major channel through which greater corporate governance influences the market response to unexpected earnings news is via lowering information uncertainty and so increasing the credibility of the information provided. Finally, we establish that the two types of uncertainty (market and information) analysed in this paper have very different influence on investor response to information signals.