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Estimation Error of Earnings Information: A Test of Representativeness and Anchoring-adjustment Heuristic

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  • Abdul Hamid Habbe

    (Faculty of Economic and Business, University of Hasanuddin, Indonesia)

Abstract

The main objective of this research is to examine representativeness and anchoring-adjustment on investors' over/under reaction to earnings information, and the consequence this has on earnings estimation and stock valuation. In particular, the over/under reaction creates an over response to the earnings information that is persistent in the long-term and an under reaction to the earnings information that changes extremely in the short-term. This research was designed with a 2 2 4, full factorial. Data was analyzed by repeated measures ANOVA within-subject. 20 post-graduate master students were participants in the experimental. The experimental revealed that investors relied heavily on previous earnings (PEs) and made the level and pattern of the PEs their initial belief (anchor). They overreact on the current earnings (CEs) information when confirming the fundamental beliefs, and they also overreacted toward persistent earnings. The results of the study confirmed that the overreaction behavior was due to of representativeness heuristic bias. On the contrary, the participant of the experiment underreacted towards the CEs information when disconfirming the fundamental beliefs, and also underreacted towards the pattern of earnings that show extreme change. The under reaction happens because of anchoring-adjustment heuristic bias. Consequently, when the previous and CEs have low (high) persistence earnings trend, they underestimated (overestimated) to the future earnings or made error in earnings estimation and underpriced (overpriced) to the securities accordingly or mispriced. It can also be concluded that the error of earnings estimation and stock mispricing is a consequence of the usage of representativeness or anchoring-adjustment heuristic, and indicates that psychological perspective can explain post earnings announcement drift in the capital market.

Suggested Citation

  • Abdul Hamid Habbe, 2017. "Estimation Error of Earnings Information: A Test of Representativeness and Anchoring-adjustment Heuristic," International Journal of Economics and Financial Issues, Econjournals, vol. 7(1), pages 224-233.
    • Handle: RePEc:eco:journ1:2017-01-29
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    References listed on IDEAS

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    Cited by:

    1. Sri Sundari & Mediaty & Abdul Hamid Habbe & Harryanto, 2018. "Heuristic of Representativeness and Anchoring-Adjustment in Budgeting," International Journal of Academic Research in Accounting, Finance and Management Sciences, Human Resource Management Academic Research Society, International Journal of Academic Research in Accounting, Finance and Management Sciences, vol. 8(4), pages 52-60, October.
    2. Hojatollah Atashi Golestani & Seyyed Mohammad Hosseini & Ehsan Mehrjoo, 2017. "Separating and Merging Cash Flows: Investigating Five-element Cash Flows Statement," International Journal of Economics and Financial Issues, Econjournals, vol. 7(4), pages 54-61.
    3. Abdul Hamid Habbe & Andi Kusumawati & Alimuddin & Yohanis Rura & Iskandar Muda, 2020. "Cognitive Moral Development, Organizational Situation and Ethical Decision Making in Business and Accounting," International Journal of Financial Research, International Journal of Financial Research, Sciedu Press, vol. 11(5), pages 93-104, October.

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    More about this item

    Keywords

    Representativeness and Anchoring-adjustment Heuristic; Overreaction and Under Reaction; Error of Earnings Estimation and Share Mispriced; Post Earnings Announcement Drift;
    All these keywords.

    JEL classification:

    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles

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