Ebook Investor Protection and the Information Content of Annual Earnings Announcements: International Evidence
A large body of research examines cross-country differences in long-window associations between stock returns and accounting earnings, and finds that earnings’ value relevance varies substantially across countries. But because this research examines long window returns-earnings associations, it cannot tell us whether investors actually use earnings information to price securities, or which factors are likely to influence cross country differences in the information content of earnings.
Thus, one purpose of this study is to examine investors’ reactions to earnings announcements using event study methodology that allows us to infer whether market participants actually use the earnings information, and to identify factors that are likely to influence differences in the information content of earnings announcements.
We draw upon the literature in investor protection institutions to identify structural factors in countries’ financial reporting environments that are likely to impact how investors respond to earnings announcements across countries. We identify four such factors and develop formal hypotheses that predict how each factor is likely to increase or decrease the information content of annual earnings announcements.
Specifically, we hypothesize that the market reaction to earnings announcements is stronger when (1) earnings are higher quality (because the earnings are more credible) and (2) there is stronger enforcement of insider trading laws (because the information is less likely to already be impounded into price). In addition, we hypothesize that the market reaction to annual earnings announcements is weaker when (3) there is more frequent interim financial reporting (because the information is more likely to already be impounded into price). Also, while we are unable to sign the prediction, we also hypothesize that the market reaction to earnings announcements is likely to be affected by (4) greater financial disclosure (because it impacts the financial reporting environment in ways that both strengthen and weaken the reaction to annual earnings announcements).
We test our hypotheses by regressing a variable that measures the information content of annual earnings announcements on variables capturing each of the four country-level structural factors that we predict to impact the information content of the earnings announcements. While we estimate our test regression at both the country-level (with each country representing a single observation) and the firm-level (with each earnings announcement representing a single observation), we rely on our firm-level regression to draw conclusions regarding our hypotheses tests because it includes firm-specific controls for several potentially omitted correlated variables. We run each regression annually and evaluate the significance of the coefficients using Fama-MacBeth statistics (Fama and MacBeth, 1973).
A second purpose of our study is to explore whether our structural factors are channels through which investor protection institutions affect the information content of earnings announcements. These tests are motivated by the observation that prior research suggests investor protection institutions engender financial reporting environments that are characterized by the structural factors we examine. Since our hypotheses conjecture that these structural factors in turn affect the information content of earnings, they indirectly suggest that our structural factors are channels through which investor protection institutions influence the information content of earnings announcements.
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