INTRAINDUSTRY INFORMATION TRANSFERS: AN ANALYSIS OF CONFIRMATORY AND CONTRADICTORY EARNINGS NEWS
Ranasinghe, Tharindra 1979-
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Prior research on intraindustry information transfers finds that earnings announcements are information events not only for the announcing firm but also for others in the industry. This paper adds to this literature by investigating whether the informativeness of a firm’s earnings surprise is conditional on the nature of the earnings news previously announced by other firms in the industry and whether the ability of current earnings to signal future firm performance (earnings persistence) differ along this dimension. I define a firm’s earnings surprise as “confirmatory” if its sign is same as that of the majority of industry members that announced their earnings previously and as “contradictory” otherwise. I hypothesize that confirmatory earnings surprises are more informative with respect to how industry-wide trends affect firm performance while contradictory earnings surprises can be more revealing of a firm’s innate strengths and weaknesses. Hence the valuation implications of earnings news can differ depending on whether they are confirmatory or contradictory. I find that the market assigns a confirmation premium to nonnegative earnings surprises that are confirmatory but that no such effect emerges for confirmatory earnings with negative surprises. Moreover, in comparison to value firms, growth firms exhibit a larger confirmation premium. Further analysis also reveals that confirmatory earnings with nonnegative (negative) surprises are more (less) persistent than earnings with contradictory surprises. Although the presence of a confirmation premium for confirmatory nonnegative earnings surprises appears to be a rational response to their greater persistence, the market does not seem to recognize the lower persistence of confirmatory negative earnings surprises. A hedge portfolio strategy of simultaneously buying and holding firms with confirmatory negative earnings surprises while short selling firms with contradictory negative earnings surprises generates an annual abnormal return of approximately 3 percent.