Agency theory predicts that information asymmetry provides agents with an incentive to manipulate performance signals to maximize their utility, which gives principals reasons to distrust such signals. The accounting and finance literature empirically supports this prediction by studying how earnings reliability attributes affect investors’ reactions to earnings announcements. However, research pays less empirical attention to whether investors who are skeptical of earnings reliability look for confirmatory signals in other parts of the income statement. This study aims to fill this research gap by examining investors’ combined use of earnings and sales news. It adopts an event-study methodology to analyze whether sales news moderates the stock market response to annual earnings announcements. The results show that investors do not fully trust earnings news if earnings beat analyst expectations and the firm has a reputation for low accrual quality. In this case, positive sales data alleviate investors’ skepticism of earnings news and, thus, make them react more favorably. In contrast, sales data do not affect the market response if the earnings news is negative or the firm's accrual quality is high. These results are robust to different model specifications and explanations. The findings shed new light on how investors use sales data to complement earnings news and our understanding of the consequences of accruals quality on investor information processing.
Accrual quality, investor reaction to earnings, and the confirmatory role of sales news
DAugusta, Carlo
2023
Abstract
Agency theory predicts that information asymmetry provides agents with an incentive to manipulate performance signals to maximize their utility, which gives principals reasons to distrust such signals. The accounting and finance literature empirically supports this prediction by studying how earnings reliability attributes affect investors’ reactions to earnings announcements. However, research pays less empirical attention to whether investors who are skeptical of earnings reliability look for confirmatory signals in other parts of the income statement. This study aims to fill this research gap by examining investors’ combined use of earnings and sales news. It adopts an event-study methodology to analyze whether sales news moderates the stock market response to annual earnings announcements. The results show that investors do not fully trust earnings news if earnings beat analyst expectations and the firm has a reputation for low accrual quality. In this case, positive sales data alleviate investors’ skepticism of earnings news and, thus, make them react more favorably. In contrast, sales data do not affect the market response if the earnings news is negative or the firm's accrual quality is high. These results are robust to different model specifications and explanations. The findings shed new light on how investors use sales data to complement earnings news and our understanding of the consequences of accruals quality on investor information processing.
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