regularities in the equity price response to earnings announcements in spain

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Regularities in theequity price response toearnings announcementsin SpainMaria Jose Arcas Pellicer & William PageReesPublished online: 10 Nov 2010.

To cite this article: Maria Jose Arcas Pellicer & William PageRees (1999) Regularities in the equity price response to earningsannouncements in Spain, European Accounting Review, 8:4, 585-607, DOI:10.1080/096381899335727

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Regularities in the equity priceresponse to earnings announcementsin Spain

Maria Jose Arcas PellicerUniversity of SaragossaWilliam Page ReesUniversity of Glasgow

ABSTRACT

This paper studies the market’s reaction to 660 earnings announcements madeduring the period 1991–95 in Spain. This period starts shortly after the completionof the revision of Spanish � nancial accounting practices to bring them into linewith EC requirements. As expected, we � nd that the earnings disclosures areaccompanied by abnormal volatility; however, we also discover positive abnormalreturns and an upward shift in beta. Furthermore, both expected and unexpectedchanges in earnings have explanatory power for abnormal returns accompanyingearnings announcements – although this result is largely driven by the smaller� rms in the sample. This evidence is consistent with a change in the risk–returnrelationship and with unsophisticated investors neglecting value-relevantinformation.

INTRODUCTION

Since Beaver’s (1968) paper, a considerable amount of evidence has beenprovided which con� rms that a � rm’s security price typically reacts to theannouncement of its accounting earnings. This is hardly surprising if it isconceded that (a) current earnings contain information about a � rm’s futureearnings and hence cash � ows, and (b) investors’ expectations concerningcurrent earnings are less than perfectly accurate. Hence, the revision ofexpectations regarding future earnings, contained in the correction of themarkets consensus on current earnings, will impact on share prices and, asinvestors re-balance their portfolios, on trading volume (Lee, 1992; Dontoh

Addresses for correspondenceMaria Jose Arcas Pellicer, Departamento de Contabilidad y Finanzas, Universidad deZaragoza, Facultad de CC. Economicas y Empresariales, Gran Via, 2, 50005,Zaragoza, Espana. E-mail: [email protected] Page Rees, Department of Accounting and Finance, University of Glasgow,65–71 Southpark Avenue, Glasgow G12 8LE, UK. E-mail: b.rees@acc� n.gla.ac.uk

The European Accounting Review 1999, 8:4, 585–607

© 1999 European Accounting Association 0963–8180

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and Ronen, 1993; Bamber and Cheon, 1995). It would seem that earningsannouncements produce a stronger market reaction than other routine an-nouncements – most particularly dividends (Patel and Wolfson, 1984;Brook� eld and Morris, 1992; Brooks, 1996).

A number of general results have become apparent from previous research.First, in an ef� cient market the price response would be expected to be fast(Patel and Wolfson, 1984; Lee, 1992). However, given trading frictions,delays in the adjustments of quoted prices, delays in information processingby investors, and a ‘cascade’ of information from more active to morepassive investors, the price changes may continue for some time. Many of thecited studies have provided evidence showing that the abnormal levels ofvolatility do continue for a few days following the disclosure (e.g. Chambersand Penman, 1984; Penman, 1984; Ball and Kothari, 1991; Pope andInyangete, 1992). Second, there is a tendency for abnormal returns to bepositive close to the date of a disclosure of accounting information (Cham-bers and Penman, 1984; Penman, 1984; Ball and Kothari, 1991). Twoalternative explanations present themselves. These concern market micro-structure and/or short-term changes in the risk of the � rms’ securities.Finally, many previous studies have found that the size of the market reactionto earnings disclosure is related to the level of unexpected earnings (Beaveret al., 1979; Pope and Inyangete, 1992), but also to the size of the � rm inquestion, the sophistication of the investors holding the shares, the level ofpre-disclosure information and even the direction of the change in earnings(Atiase, 1985; Grant, 1980; Shores, 1990; Potter, 1992; Shevlin and Shores,1993; Elsharkawy and Garrod, 1996).

Although a considerable amount of evidence has been produced regardingthe price reaction to earnings announcements the majority of such studiesrelate to circumstances in the US, and to a lesser extent to the UK. There aremany reasons why these results might not apply to continental Europe ingeneral and Spain in particular. The US has a developed sophisticatedsecurities market where considerable resources are devoted to investmentanalysis. The accounting system is also highly developed, closely regulatedand designed, in part at least, to meet the needs of investors. Finally, thedisclosure of information to investors is a clear event with rapid dissemina-tion of the information once disclosed as constraints exist on its release, andin its use in trading, prior to the formal publication of the results. With thepossible exceptions of the UK, Ireland and the Netherlands, Western Euro-pean accounting practices have been designed primarily for users other thaninvestors, investment analysis receives relatively little resources and thesecurities markets are less regulated. Whilst these assertions may be seen ascontentious in general, their relevance to Spain has been fairly obvious. Inthe early 1980s audited accounts were not compulsory; consolidated groupaccounting was unusual and unregulated; the disclosure and dissemination ofearnings information was erratic to the point where it was often dif� cult to

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identify a disclosure date; and, whilst it is dif� cult to comment on thesophistication of investors, it is clear that the equities market was relativelyunderdeveloped with few stocks, many of which were relatively illiquid, andwith low capitalization. By the early 1990s much of this had changed. Thismakes Spain a particularly interesting example in having moved from whatwas, within the Western European context, at the opposite end of thespectrum from an Anglo-American environment for earnings disclosure, toone which is, arguably, comparable with best practice.

Thus, we present results for a country that had recently operated ataxation- and debtor-driven accounting system, with stock market practiceswhich gave little opportunity for Anglo-American-style investment analysis,but which subsequently incorporated changes moving towards investor-ledaccounting and stock market regulations which facilitate disclosure, analysisand trading. Our results are similar to those observed in the UK and US.Whilst we do not have evidence concerning the pre-reform era, given thecomments made in the previous paragraph and discussions with analysts whooperated during the earlier era, we believe that results for the 1980s wouldprobably have been rather different. As pointed out by an anonymousreviewer, this does at least provide a point of departure for the progress thatcan be expected in other European countries, particularly those from the East,which are currently undergoing or contemplating similar developments.

In the next section the particulars of the Spanish environment are dis-cussed. This is followed by an explanation of the methodology employed inthe research. The penultimate section presents the results, followed by theconclusion.

ACCOUNTING AND SECURITY MARKETS IN SPAIN

In 1989, substantial legislative changes were introduced1 to bring Spanishaccounting practices into line with best practice in the EU. Some of thesechanges were not compulsory until 1991 although some � rms introducedthem well in advance of the required date – in many cases before thelegislation was passed (e.g. Mora and Rees, 1998). Stock market changeswere started in 19882 but again the relevant date for implementation spans anumber of years. The current approach is presented as a contrast with theearlier system, although it does not fall within our sample, as it and theresults pertaining to it should be interpreted in the light of the recent andsubstantive changes that have occurred.

The accounting system

Until 1989 accounting information in Spain was regulated by commerciallaws, which related, in the main, to its formal requirements, rather than itseconomic aspects. Many commentators believed that the Spanish accounting

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system and accounting rules were obsolete when contrasted with the develop-ment in the Spanish economic and business systems during the previousdecade. A reform in commercial laws and in the accounting system wasinstigated and there were probably two main reasons for these accountingreforms.

First, the commercial laws and the accounting system were no longerrelevant to the Spanish economic system and the needs of accountinginformation users. The General Accounting Plan (issued in 1973 and en-compassing the main body of accounting regulations) no longer conformedwith International Accounting Standards with respect to leasing, foreignexchange and income tax, amongst others, and did not address certain otheraspects such as accounting for pensions.

Second, the Spanish integration into the EU obliged Spanish regulators tocomply with EU directives. In this respect the Spanish system was rather late,although not uniquely so, in enacting the necessary laws to comply with EUregulations.

The main points of the accounting reform can be summarized asfollows:

(a) The new objectives of the annual accounts (balance sheet, pro� t andloss account and annex) are to give a true and fair view of the worthof the � rm, its � nancial situation and the results of the company.

(b) The valuation criteria, contents and presentation of the annual ac-counts became prescribed, and the accounting information that com-panies must disclose was increased.

(c) The new regulations established compulsory presentation of consoli-dated annual accounts for groups (with the exception of small groups)and the rules to prepare them.

(d) Compulsory auditing of annual accounts was instigated (althoughagain there was an exception for small companies).

(e) The requirement to publish annual accounts for all companies thatlimit the liability of its owners was established. These must bedeposited as a public record in the Mercantile Register. (In recentyears many companies failed to comply with this requirement, and inMarch 1995 the � nes for not � ling the annual accounts wereincreased.)

(f) Prior to 1989 the tax rules were the principal rules relevant to thepreparation of accounting statements. The 1989 reform established thedistinction between accounting practices and tax laws and it becameexplicit that tax computations were not relevant for � nancial reporting.However, it would seem that accounting practice is still much in� u-enced by taxation, albeit mainly in small and medium-sizedcompanies.


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The stock market system

The main reform of the Spanish stock market took place in 1988 and wasnecessary for three main reasons.

First, the trading system was outdated and slow. The trading procedurewas open outcry and took place during a few minutes of each day, when thedemand and the supply for a particular stock were matched. The settlementprocedures were also very slow.

Second, the Spanish stock market consisted of four independent exchanges(Madrid, Barcelona, Valencia and Bilbao) without any formal relationshipbetween them. As a consequence the trading of any one particular stockcould be dif� cult where the demand and supply in each exchange could notbe easily matched. A strong case for an integrated market was made.

Third, there was also a need to develop the Spanish stock market becauseof integration within the EU.

The stock market reform’s main objectives were to increase the stockmarket transparency, to reduce operating costs in the market, to increasecompetition and trading volume, and to improve the system for the settlementof transactions.

The main points of the stock market reform can be summarized asfollows:

(a) The Comision Nacional del Mercado de Valores (Stock ExchangeCommission) was established. This body supervises the activity of thestock market and the activity of the persons that trade in the market.Among other functions this includes the admission to trading of thestocks; investor protection; ensuring transparency in trading andprices; and enforcement and compliance.

(b) Creation of a Sistema de Interconexion Bursatil (Stock ExchangeInterconnection System). The system that has been introduced is theCATS (Computer-Assisted Trading System) also used by the TorontoStock Exchange. Gradually, it has replaced the open outcry tradingsystem in each stock exchange. This system effectively provides anintegrated market instead of the four disparate markets previouslyinvolved. It also provides a continuous market for trading for sevenhours per day. The purpose of this system is to speed tradingprocedures, to increase market ef� ciency, to disseminate informationrapidly and to increase trading volume.

(c) New agents were also introduced. The former Agentes de Cambio yBolsa (similar to stockbrokers) were replaced by the Agencias deValores and Sociedades de Valores (securities houses). The mainchange is that the need for an af� davit ( fe publica) for transactionswas removed. Furthermore, trading commissions and fees wereliberalized.


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(d) There was also a substantial increase in the accounting informationthat listed companies are required to disclose. Since the reform, listedcompanies must provide audited annual accounts. The interim ac-counting information that companies must disclose was also increased.Quarterly reports must disclose information about results, dividends,signi� cant events and business development. The half-year reportsmust disclose the pro� t and loss account, balance sheet, businessdevelopment, segment information and information regarding sig-ni� cant events. The � gures corresponding to the same period of theprevious year must also be disclosed.

Taken together the stock exchange and accounting reforms produced asystem which appears to be similar to those of other EU and developedWestern-style economies. Whether the appearance of development andharmonization is matched by the substance is something that studies such asthe one reported here will help to decide.

DATA AND METHODOLOGY

The sample is constructed from the Extel Financial Equity Research service(see Table 1). A search for announcements concerning earnings disclosuresin Spain covered the period from September 1991 to May 1995 and produced973 cases. However, detailed examination revealed that 113 cases did notrefer to the disclosure of accounting earnings, 60 were further detailsconcerning an announcement that had previously been made, 36 wereaccompanied by another earnings announcement for the same � rm on thesame date (often separate disclosures for the holding company and group),

Table 1 Sample design

IBEX35cases

Non-IBEX35cases Total

Total cases 433 540 973

Non-earnings announcements 2 51 2 62 2 113Stock prices not available 2 11 2 93 2 104Duplicated announcements 2 15 2 21 2 36Second announcements 2 46 2 14 2 60

Useful cases 310 350 660

Annual 101 122 223Interim-quarterly 209 228 437

Notes:Row 1 is the total sample for 1991 to 1995 derived from a search for earnings announcements onthe Extel Financial Equity Research database. The following four rows show the number of thosecases which are not suitable for analysis for various reasons. The � nal three rows give the totalnumber of cases and their split between year-end announcements and interim announcements .


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leaving 764 relevant cases. Share price information was collected from thesame source and was adjusted for dividend payments and capitalizationchanges. Adequate share price information was not available for 104 cases,leaving a � nal sample of 660 useful cases. Of these, 223 cases referred to thedisclosure of annual earnings and 437 to the disclosure of interim results. Atotal of 310 cases referred to � rms that were constituents of the IBEX35index whereas the remaining 350 were not. (The IBEX35 is an index formedfrom the 35 most liquid stocks on the Spanish markets and are exclusivelylarge capitalization stocks.)

The IBEX35 classi� cation is of interest for two reasons. First, previousresults have indicated that we can expect somewhat different results for largeand small � rms, and the IBEX35 provides a convenient and independentclassi� cation between these two groups. Second, there are dif� culties in-volved in calculating abnormal stock price returns for less liquid � rms.Normal practice is to estimate a market model based on a period whichprecedes the event window. There are a number of theoretical and practicalreasons why this may cause problems. We have already mentioned that USevidence suggests that risk changes may be observed around the time of anearnings announcement and therefore there is an obvious problem withestimating a market model out of the sample and assuming it is valid withinthe test window. Furthermore, the results from Fama and French (1992) andsubsequent studies have cast considerable doubt on the validity of betaestimates as an effective measure of risk.

The practical reasons for not relying solely on the conventional marketmodel approach are twofold:

(a) Thin trading is severe for many � rms in the Spanish stock market andespecially for these outside the IBEX35 and, whatever adjustmentprocedures are employed, this thin trading is likely to bias theestimates.3

(b) For many of the smaller � rms the data requirements would severelylimit the sample.

However, as most previous studies have used the market model we in-vestigate the sensitivity of the results to using either the market model, or amarket adjustment. The test was restricted to those cases when the � rm is aconstituent of the IBEX35. The market model is estimated as

Ri,t 5 a 1 b Rm,t 1 e i,t (1)

where Ri,t is the return for � rm i, Rm,t is the return on the general market index(GMI), day t, a i and b i are the estimated parameters for � rm i, whilst e i,t isthe conventional OLS error term. The GMI is a capitalization weighted indexwhich includes most Spanish stocks. The estimation window is 250 daysending 11 days prior to the earnings announcement date.

The results of this estimation are given in Table 2 and it can be seen thatthe mean a and b are relatively close to zero and one respectively, although


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conventional t-tests reveal that they are signi� cantly different from theexpected values in statistical terms. It is also encouraging that the minimumand maximum readings are not unreasonable. That the beta estimate in asample of liquid stocks such as the IBEX35 is on average greater than onewhen regressed against a general index is not surprising and suggests thatthin trading is not a problem for these stocks.

Abnormal returns are calculated as

ARMMi,t 5 Ri,t 2 (ai 1 bi Rm,t) (2)

for the market model estimates where ai and bi are the estimated coef� cientsfor � rm i from Equation (1), and

ARMAi,t 5 Ri,t 2 Rm,t (3)

for the market-adjusted estimates. Although we report results based on bothestimates it would appear that these results are not particularly sensitive tothe method of estimating abnormal returns. For example, the averageabsolute abnormal return and the average abnormal return for the IBEX35sample from day 2 10 to day 1 25, based on market model and market-adjusted returns, reveal a correlation of 0.957 for the absolute returns and0.965 for the signed returns. The mean absolute returns are 0.01078 and0.01074 and signed returns are 2 0.00012 and 0.00021 for the market modeland the zero–one model respectively. In both cases neither of these estimatesis signi� cantly different. Little evidence is available regarding the behaviourof Spanish stock returns but Ocana et al. (1997) also use market model andmarket-adjusted returns, and supplement this with estimates adjusted for thintrading, using the approach Cohen et al. (1983) advocate. Even though theyuse a 320-day window in their investigation of the market reaction totakeovers they report no signi� cant difference between the three methodsused. This insensitivity to the method of calculating abnormal returns is verymuch as expected for the short event windows employed in this study(Brown and Warner, 1985). Nevertheless the in� uence of � rm size in many

Table 2 Market model estimations

a b

Mean 0.0003 1.0614Standard deviation 0.0009 0.2980Maximum 0.0031 1.9710Minimum 2 0.0029 0.3839Number of observations 310 310

Notes:Descriptive statistics for the results of market model estimation for the 310cases where the � rm was a constituent of the IBEX35 index. The modelwas estimated using daily returns for a 250-day estimation window endingeleven days before the earnings announcement .


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studies in � nance and market-based accounting research suggests that itwould be wise to ensure that the results are not contaminated by size effects.To this end we have investigated the association between market capital-ization and abnormal returns, however measured, and have been unable to� nd any signi� cant effects for windows up to and including the longest51-day window we employ.4 This does not imply that the common size effectis not present in Spanish stock returns – only that it does not affect oursample or is, more probably, too small to notice given the short eventwindows.

Tests of volatility

The � rst test examines the volatility of security returns at the time of theearnings announcement. Tests of volatility often use Patel’s statistic but

(a) this is found to be biased against the rule of no excess volatility if thedistribution of returns is leptokurtic, as is usual; and

(b) corrections of Patel’s statistic require a reliable estimation periodwhich is not available for most � rms in our sample due to thin tradingor data limitations.

Consequently, following Walmsley et al. (1992), a non-parametric test isused which simply ranks the absolute abnormal return across the 51-daywindow, centred on the disclosure date for each case in the sample. The meanrank and standard deviation of the ranks can be calculated for each day in the51-day window and a conventional t-test can be used to examine whether themean rank is signi� cantly different from the rank expected if there were nodifference in volatility across the 51 days. A 51-day window is chosen as therank-based tests require a reasonable sample of non-event days within thewindow with which to compare the days where unusually high volatility isexpected. Given approximately 250 trading days in the year, and fourearnings announcement events, 51 days (� ve weeks each side of the eventplus the event day itself) is a compromise between ensuring that enough daysare included in the window and that the event windows do not overlap.Formally, let xi,t be the rank of the absolute abnormal return of company i onday t, and

Xt 51

NON

i 5 1Xi,t (4)

Under the null hypothesis successive xi’s are independent, and therefore

SE(Xt) 5s (Xi,t)

Ï N(5)


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The test statistic used to judge the signi� cance of Xt, the mean rank for aparticular day t in the event window, is

Zt 5(XtE(Xt))

SE(Xt)(6)

Under the null hypothesis Zt is a unit normal variate and t-tests areappropriate.

Tests of abnormal return

Whilst erratic returns might be expected following an earnings announcementa naive view might suggest that investors should have an unbiased expecta-tion of the earnings announcement and therefore unexpected earnings are aslikely to be negative as positive. Consequently, abnormal returns should beexpected to be zero. Previous evidence suggests that this may well not be thecase. It is appropriate therefore to test whether the average abnormal returnsare signi� cantly different from zero. As the results may be driven by outliersthe robustness of the results are examined by, in turn,

(a) truncating outliers; or(b) removing outliers; or(c) using non-parametric tests equivalent to those employed for testing

volatility.

As it is apparent that abnormal returns may be dissipated over a number ofdays, cumulative abnormal returns are also calculated where the returns arecumulated over the 51-day window for the IBEX35, non-IBEX35 and fullsample using market-adjusted returns, so as to coincide with the volatility testwindow, and, as with the volatility-based tests, to provide enough within-window days to provide a reliable benchmark for the rank-based tests. Herethey are only used as a sensitivity check on the parametric results. Thiswindow is probably longer than is necessary for the CAR-based tests, andlonger windows will be more sensitive to any misspeci� cation of expectedreturns, so we also examine the effect of using shorter windows. For themarket model-based analysis using the IBEX35 subsample, which is itselfused as a check on the robustness of the simpler but less problematic market-adjusted model and for which we do not conduct non-parametric back-uptests, we restrict the abnormal returns and CAR tests to a window of 21 days(the event day itself plus two working weeks before and after).

The mean cumulative abnormal returns for day D are calculated as

CARD 5

ON

n 5 1 S P Dd 5 2 25

(1 1 ARi,d) 2 1DN

(7)


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Cumulative abnormal returns adjusted for time-varying risk

It has previously been mentioned that risk, and hence expected return, maybe thought to vary across the event window. Following Ball and Kothari(1991) we estimate cross-sectional models of individual company returns andmarket returns. As differences in thin trading may affect the results thesample is again split between IBEX35, non-IBEX35 and the full sample.Thus the model is

Ri,d 5 a d 1 b dRm,d 1 m i,d (8)

where d identi� es the day in the event window, a d and b d are the estimatedcoef� cients and m i,d the conventional OLS error term. As with other estimatesof abnormal returns a d can be cumulated over the event window. The OLSestimation procedure provides standard error estimates used to examinewhether a d and b d are signi� cantly different from zero and onerespectively.

The question then arises as to whether any estimated variation in riskexplains the variation in returns estimated using the methodology outlinedabove. This is examined by modelling the relationship between the estimatesof a d and b d based on the presumption that high returns should accompanyhigh risk (Gibbons, 1982). The estimated model is

a d 5 g 0 1 g 1( b d 2 1) 1 m d (9)

where a d is the estimated intercept from Equation (8) for day d in the eventwindow and b d is the corresponding estimate of the response to marketmovements. The second term is b d 2 1 as we have the prior expectation thatwhen b d equals one a d should be zero. The model is estimated using varioussamples from within the event window. There is an obvious case for usingthe full 51-day window consistent with the volatility and return testsdescribed above. Conversely a shorter window focuses on the event inquestion and excludes days when the variation in the estimates is probablyrandom as there is no reason to expect change in risk for a stable sample withno event to disturb the risk–return relationship.

Tests of association between earnings and returns

Since Beaver et al. (1979) it has been apparent that a positive associationexists between unexpected earnings and the market reaction to earningsannouncements. More recent studies have demonstrated that this associationis more complex than � rst thought. The size of the � rm, the sophistication ofinvestors in the � rm and the direction of unexpected earnings have all beenshown to have a signi� cant in� uence (Shores, 1990; Pope and Inyangete,1992; Potter, 1992; Shevlin and Shores, 1993; Elsharkawy and Garrod,1997). We conduct a simple test which makes use of analysts’ consensusforecast collected by I/B/E/S as, probably, the best available measure of


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expected earnings (e.g. Fried and Givoly, 1982); we choose CARs which arecumulated over an event window which seems to include most of theresponse to the earnings announcements as revealed in our earlier tests; andwe segment the sample between IBEX35 and non-IBEX35 � rms to capturedifferences in the � rms’ investor base. By using analysts’ forecasts werestrict ourselves to annual earnings and the sample is reduced to 192 as wewere unable to obtain analysts’ forecasts for 31 cases.

A case could be made for estimating a time-series model of earningsexpectations but, in general, time-series models have little explanatory powerand rarely improve signi� cantly on a random walk. Furthermore, the changein accounting practices just before the start of our sample prevents us fromobtaining suf� cient data points to estimate a time-series model. Larran andRees (1999) provide evidence that analysts’ forecasts extant at the accountingyear-end explain approximately 60% of the change in earnings experiencedby Spanish � rms. We are not aware of any time-series study which has comeanywhere near providing comparable explanatory power.

The model we estimate is

CARi 5 d 0 1 d 1(EECi) 1 d 2(UECi) 1 m i (10)

Here CARi are the abnormal returns cumulated from day 2 3 to day 1 9 for� rm i, EECi are expected earnings changes and UECi are unexpectedearnings changes. This choice of window is based on the results of the testsdescribed above which suggest that the market reaction to earnings announce-ments is largely contained within these 13 days. EECi and UECi are de� ned as(FEPSy 5 0 2 EPSy2 1)/ï EPSy2 1ï and (EPSy5 0 2 FEPSy5 0)/ï EPSy 2 1ï respec-tively where EPSy is the actual earnings per share for year y. FEPSy is the lastconsensus forecast of earnings per share for year y available before the earnings� gure was disclosed. d 1, d 2, d 3 and m i are the OLS estimates of the coef� cientsand the OLS error term respectively.

RESULTS

Table 3 presents the estimated average absolute abnormal returns for eachday in the event window, and the non-parametric rank test of signi� cance.For the sake of clarity the table is restricted to days 2 10 to 1 10. Despite thesimplicity of the test method employed the results are clear. Whatever thesample or test procedure, days 0 and 1 1 demonstrate the highest volatility intheir respective 51-day event window – not only the 21 days revealed inTable 3. For days 2 1 to 1 4 the level of volatility is signi� cantly higher thannormal. The volatility for the smaller non-IBEX35 � rms seems to bemarginally higher – as would be expected given the relative scarcity ofinformation regarding smaller � rms. The sample has also been split betweenannouncements of annual earnings and announcements for interim earnings(not reported in Table 3). The volatility accompanying the disclosure of


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interim earnings is actually marginally higher than those for annual earnings.For example, the volatility (mean absolute market-adjusted return) on day 0is 0.1716 for interim announcements compared with 0.1545 for annualannouncements, but the excess volatility is signi� cant for slightly less time.Only days 2 1, 0 and 1 1 are signi� cant for interim announcements whilstdays 1 2 and 1 4 are also signi� cant for annual announcements. Takentogether the results regarding the share price reaction to earnings disclosurescon� rm that, whatever the situation before the new accounting regime inSpain, the current situation is remarkably like that in other Western devel-oped economies with earnings announcements being accompanied by a clearprice reaction and the associated volatility lasting for a few days.

Table 3 Tests of volatility

All cases

DayIBEX-35(MM)

IBEX-35(0–1M)

Non-IBEX35(0–1M) (0–1M) Rank means t-Statistic p-Value

2 10 0.009 0.010 0.146 0.012 25.103 2 1.560 0.1182 9 0.011 0.011 0.016 0.014 24.853 2 1.970 0.0492 8 0.010 0.010 0.017 0.013 25.438 2 1.000 0.3192 7 0.010 0.010 0.017 0.014 25.778 2 0.380 0.7042 6 0.010 0.010 0.015 0.013 25.271 2 1.290 0.1972 5 0.010 0.010 0.018 0.014 25.942 2 0.100 0.9212 4 0.010 0.010 0.020 0.015 26.374 0.630 0.5282 3 0.011 0.011 0.017 0.014 26.831 1.470 0.1422 2 0.010 0.010 0.018 0.015 26.238 0.420 0.6722 1 0.012 0.012 0.019 0.016 28.275 4.150 0.000

0 0.013 0.012 0.020 0.017 28.361 4.110 0.0001 0.012 0.012 0.021 0.017 28.620 4.680 0.0002 0.011 0.011 0.018 0.015 27.227 2.190 0.0293 0.011 0.011 0.019 0.015 27.164 2.040 0.0424 0.012 0.012 0.019 0.015 27.461 2.600 0.0095 0.011 0.011 0.017 0.014 25.700 2 0.530 0.5936 0.010 0.010 0.017 0.014 26.181 0.330 0.7447 0.010 0.010 0.016 0.013 25.337 2 1.160 0.2458 0.012 0.012 0.017 0.015 27.427 2.530 0.0129 0.012 0.012 0.014 0.013 26.069 0.120 0.902

10 0.011 0.011 0.015 0.013 26.587 1.040 0.298

Notes:Columns 2 to 5 report the mean absolute abnormal return for each day in the event window, asidenti� ed in column 1, for the IBEX35 subsample in columns 2 and 3, for the non-IBEX35subsample in column 4 and for the full sample in column 5. The abnormal returns in column2 are calculated using the market model, and in the three other columns they are calculatedusing a simple market adjustment. Column 6 contains the mean, across the full sample, of therank of each � rm’s volatility where the rank is calculated across the full event window of 51days based on market-adjusted returns. Column 7 reports the t-statistic from the test that themean rank is signi� cantly different from the unconditional expected rank (26) and column 7contains the associated signi� cance level. The table has been restricted to the middle 21 daysin the event window for the sake of clarity.


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Table 4 reports the average abnormal returns for each day in the restricted2 10 to 1 10 window. In the window prior to day 2 1 and after day 1 4average daily returns oscillate between positive and negative. From day 2 1until day 1 4, or day 2 2 to day 1 5 for the full sample, the average returns,whether measured using the market model or market adjustment or whetherusing the IBEX35 sample or not, are uniformly positive. The occasionalindividually signi� cant days ( 2 8, 2 3 and 1 8) are apparently caused byoutliers. If outliers are truncated or removed, or where the non-parametricranks test is employed, these are no longer signi� cant, but the basic patternof positive returns from day 2 1 to 1 4 is retained. Even if these three casesare taken at face value they will be shown to be relatively unimportant whencompared with the run of positive results. When the sample is split betweenannual and interim announcements some minor differences are observed

Table 4 Tests of abnormal returns

All cases

DayIBEX-35(MM)

IBEX-35(0–1M)

Non-IBEX35(0–1M) (0–1M) t-Statistic p-Value

2 10 2 0.0007 2 0.0003 0.0010 0.0004 0.490 0.6282 9 2 0.0022 2 0.0020 2 0.0009 2 0.0014 2 1.160 0.2482 8 0.0003 0.0005 0.0037 0.0022 2.580 0.0102 7 0.0009 0.0011 0.0001 0.0006 0.650 0.5152 6 0.0002 0.0006 2 0.0007 2 0.0001 2 0.130 0.8962 5 2 0.0011 2 0.0006 0.0016 0.0006 0.620 0.5342 4 2 0.0007 2 0.0002 0.0005 0.0002 0.200 0.8442 3 2 0.0009 2 0.0002 2 0.0037 2 0.0021 2 2.460 0.0142 2 2 0.0009 0.0002 0.0004 0.0003 0.320 0.7512 1 0.0004 0.0010 0.0024 0.0017 1.860 0.063

0 0.0019 0.0019 0.0012 0.0015 1.500 0.1351 0.0006 0.0012 0.0005 0.0009 0.800 0.4232 0.0016 0.0020 0.0014 0.0017 1.840 0.0673 0.0008 0.0011 0.0020 0.0016 1.730 0.0844 0.0016 0.0020 0.0010 0.0015 1.500 0.1335 0.0021 0.0021 2 0.0001 0.0009 0.930 0.3516 0.0001 0.0005 2 0.0009 2 0.0002 2 0.270 0.7857 0.0000 0.0003 0.0022 0.0013 1.560 0.1208 0.0032 0.0037 0.0011 0.0023 2.550 0.0119 2 0.0002 0.0002 0.0024 0.0014 1.710 0.088

10 2 0.0003 2 0.0001 0.0002 0.0001 0.070 0.945

Notes:Columns 2 to 5 report the mean abnormal return for each day in the event window, asidenti� ed in column 1, for the IBEX35 subsample in columns 2 and 3, for the non-IBEX35subsample in column 4 and for the full sample in column 5. The abnormal returns in column2 are calculated using the market model, and in the three other columns they are calculatedusing a simple market adjustment. Column 6 contains the t-statistic from the test that the meanabsolute return is signi� cantly different from zero and column 6 reports the associatedsigni� cance level. The table has been restricted to the middle 21 days in the event window forthe sake of clarity.


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(although not reported in Table 4). For interim announcements all days from2 2 to 1 5 are positive whilst for annual earnings days 0 and 1 1 record smallnegative returns; however, positive returns for the subsequent four days aresomewhat larger than those experienced during the interim announcementsover the same period. For the subsample of annual announcements recordingan increase in earnings over the previous year mean returns are positive fromday 2 1 through to day 1 11, save for day 1 6. Those annual announcementswith a decrease in earnings have six negative and seven positive mean returnsover the same period.

The positive returns accompanying earnings announcements can be moreclearly observed using cumulative abnormal returns. From day 2 25 until day2 2 little happens, but from that date a clear upward trend is observed whichpeaks at day 1 9 for IBEX35 � rms, and at day 1 22 for non-IBEX35 � rms.For the full sample the mean CAR is signi� cantly different from zero fromday 1 3 onwards. These results are presented in tabular form in Table 5 andgraphically in Figure 1. Following a suggestion from one of the referees wehave examined rolling three-day cumulative returns. This produces a clearerresult that the daily returns used in Table 4 although the sense of the resultis unchanged. Using the three-day rolling CARs of the 12 three-day windowscentred on day 2 1 through to day 1 10 all are positive and nine aresigni� cantly so.

The most convincing explanation for the increase in abnormal returns is anincrease in risk. The results of the cross-sectional regressions are given inTable 6. Two striking results can be observed. First, the run of positiveabnormal returns from day 2 1 until 1 5 is also apparent using the newestimations procedure. In this case abnormal returns are indicated by the a ’s.Second, the estimated b ’s are all greater than one during this period. Thereare only 20 out of 51 point estimates of b which are greater than one andseven of these occur on the seven days commencing on day 2 1. Even if weassume a 50:50 chance of observing b greater than one, rather than the 20:31ratio implied by our estimates, seven such consecutive observations are onlyto be expected less than once in every 100 repetitions.

There is an alternative explanation. If some � rms are usually thinly traded,but the disclosure of accounting information stimulates trading, both beta andexpected returns would be higher during this period. However the results are,if anything, clearer for the more liquid IBEX35 sample suggesting that theresult is not driven by thin trading, and the size of the abnormal returns is toolarge to be explained as an accumulation of expected returns over a few daysof non-trading.

Further investigation of the relationship between risk and returns supportsthe presumption that changes in risk explain apparent changes in abnormalreturn. The results of regressions of abnormal returns modelled on beta aregiven in Table 7. Here abnormal returns are de� ned as the a estimated fromEquation (9).5 Two sets of results are included in Table 7. The � rst use the


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full 51-day window centred on the disclosure date as this is the full set ofinformation available from the earlier analysis. A shorter window of 21 days,also centred on the disclosure day, is included as the full window appears tocontain tails in which little change in the beta or abnormal return is observed.Thus the shorter window focuses on the events of interest to this analysis.

The results for the full 51-day window are rather weak. There is a positiverelationship between a and b but it is not statistically signi� cant. However,when the window is reduced to 21 days, and the analysis is therebyconcentrated on the period in which substantive earnings disclosure-drivenchanges occur, the b -coef� cient is positive and statistically signi� cant.Indeed explanatory power of more than 27% is quite impressive.

In the � nal analysis the cumulative abnormal return over a 13-day windowis modelled by both expected and unexpected earnings changes as per

Table 5 Tests of cumulative abnormal returns

Full sample

Day IBEX-35 Non-IBEX35 Full sample t-Statistic p-Value

2 10 0.0082 2 0.0013 0.0032 1.000 0.3192 9 0.0061 2 0.0020 0.0018 0.540 0.5872 8 0.0067 0.0016 0.0040 1.130 0.2572 7 0.0078 0.0020 0.0047 1.280 0.2022 6 0.0082 0.0011 0.0044 1.200 0.2322 5 0.0075 0.0027 0.0049 1.310 0.1922 4 0.0074 0.0030 0.0050 1.300 0.1942 3 0.0072 2 0.0006 0.0031 0.770 0.4442 2 0.0074 0.0001 0.0035 0.850 0.3982 1 0.0082 0.0027 0.0053 1.210 0.225

0 0.0100 0.0040 0.0068 1.540 0.1241 0.0113 0.0045 0.0077 1.700 0.0892 0.0132 0.0065 0.0096 2.030 0.0423 0.0144 0.0079 0.0110 2.310 0.0214 0.0164 0.0091 0.0125 2.560 0.0115 0.0188 0.0088 0.0135 2.690 0.0076 0.0193 0.0079 0.0133 2.620 0.0097 0.0197 0.0101 0.0146 2.810 0.0058 0.0236 0.0107 0.0167 3.180 0.0029 0.0237 0.0127 0.0179 3.390 0.001

10 0.0231 0.0130 0.0177 3.340 0.001

Notes:The abnormal returns are cumulated from day 2 25 through to day 1 25 – although for the sakeof clarity the table is restricted to a 21-day window centred on the event date. Column 1identi� es the days relative to the disclosure date (day 0) and columns 2, 3 and 4 report thecumulated abnormal return for the IBEX35 subsample, the non-IBEX35 subsample and the fullsample. The abnormal returns are all calculated using simple market-adjusted returns. Column5 contains the t-statistic for the test that the CARs are different from zero and the � nal columncontains the associated signi� cance level.


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Equation (10). The results are shown in Table 8. The choice of the eventwindow is problematic. The 13-day window is chosen as this would appearto capture those days with abnormal volatility (see Table 3) and those inwhich the CAR changes signi� cantly (see Figure 1). A reviewer has pointedout that comparability with previous papers would be aided by using a three-day window centred on day 0, but our earlier results show that most three-day windows throughout the 13-day window we have used are signi� cantlydifferent from zero. Thus we have chosen to include all days on which wehave abnormal volatility or returns which seem to be related to the earningsdisclosure to try and capture the full reaction. It is possible that we have useda longer window than necessary but if that is the case we will have capturedirrelevant returns in the dependent variable which might weaken the power ofthe test. There is no reason to suppose that extending the window willintroduce bias into the analysis. The model is estimated for all � rms forwhich I/B/E/S consensus earnings forecasts are available shortly before theearnings announcements and also for IBEX35 and non-IBEX35 subsamples.The presumption is that more resources are devoted to the analysis of thelarger more liquid IBEX35 � rms than for the non-IBEX35 � rms and that thelatter group can be thought of as representing relatively unsophisticatedinvestors – or at least � rms for which professional � nancial analysts willdevote relatively few resources.

Figure 1 Cumulative abnormal returns based on the 0,1 model


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For both the full sample and the non-IBEX35 sample both expected andunexpected earnings changes have signi� cant explanatory power – of 12%and 20% respectively. As neither expected nor unexpected earnings changeshave signi� cant explanatory power for the IBEX35 subsample it is clear thatthe results are being driven by the non-IBEX35 subsample.

The interpretation of the results for the non-IBEX35 sample is quitestraightforward. The market reacts to unexpected earnings as predicted butalso reacts to earnings changes which had already been forecast by analysts.The most obvious explanation is that some investors have not incorporatedthe information contained in analysts’ consensus forecasts into prices.Elsharkawy and Garrod (1996) � nd similar evidence, and adopt a similarinterpretation, when looking at UK data.

The absence of explanatory power for expected earnings for the IBEX35sample is to be expected. The information contained in analysts’ consensus

Table 6 Cross-sectional regression

Day a t-Statistic p-Value b t-Statistic p-Value

2 10 0.0002 0.180 0.857 1.067 0.646 0.5192 9 2 0.0020 2 1.353 0.177 0.983 2 0.109 0.9132 8 0.0016 1.605 0.109 0.902 2 0.895 0.3732 7 0.0013 1.512 0.131 0.981 2 0.203 0.8392 6 0.0002 0.195 0.846 0.846 2 1.494 0.1372 5 0.0001 0.104 0.917 0.932 2 0.691 0.4912 4 0.0011 0.938 0.349 0.888 2 1.118 0.2662 3 2 0.0013 2 1.305 0.193 0.824 2 1.847 0.0672 2 0.0014 1.323 0.187 1.015 0.160 0.8732 1 0.0024 2.194 0.029 1.045 0.463 0.644

0 0.0020 1.726 0.085 1.111 1.108 0.2701 0.0009 0.691 0.490 1.169 1.449 0.1502 0.0010 0.881 0.379 1.215 1.976 0.0503 0.0023 2.250 0.025 1.215 2.154 0.0334 0.0026 2.350 0.019 1.109 0.990 0.3245 0.0015 1.528 0.127 1.069 0.668 0.5056 2 0.0002 2 0.191 0.848 0.750 2 2.462 0.0157 0.0011 1.248 0.213 0.999 2 0.012 0.9918 0.0025 2.630 0.009 1.144 1.538 0.1279 0.0015 1.533 0.126 1.034 0.358 0.721

10 0.0000 0.053 0.958 0.983 2 0.179 0.858

Notes:This table contains the results of the cross-sectional OLS regressions of � rm returns (Ri,d) onmarket returns (Rm,d):

Ri,d 5 a d 1 b d Rm,d 1 m i,d

Although the regressions were estimated for each day in the 51-day event window for the sakeof clarity only the middle 21-day results are reported in the table. These results refer to the fullsample although additional tests were also conducted on the IBEX35 and non-IBEX35subsamples.


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forecast has apparently been incorporated into prices. The lack of explanatorypower for unexpected earnings changes is more puzzling. It should be notedthat the coef� cient on d 2 is very similar for both subsamples and it ispossible, by altering the event window, to produce results which demonstratea signi� cant positive relationship between unexpected earnings changes andCARs. However, this result is obviously less robust than for the non-IBEX35sample and there is a relatively convincing, though unprovable, rationaliza-tion. The expected changes in earnings are based on the last available I/B/E/Sconsensus forecast published prior to the announcement of the � rm’searnings. Thus some time elapses between the publication of the forecast andthe announcement of the earnings. I/B/E/S forecasts – like any otherconsensus earnings forecast – amalgamate relatively old forecasts along with

Table 7 Risk and return model

Window g 0 g 1 R2 F

51 0.0004 0.0019 3.1 2.60(2.71) (1.61)

21 0.0009 0.0053 27.3 8.52(3.90) (2.92)

Notes:This table contains the results of the models of sample abnormal returns(alpha) on estimated risk parameter (beta):

a d 5 g 1 g 1(1 2 b d) 1 m d

The regressions were estimated for the 51-day event window and forshorter 31- and 21-day windows centred on the announcement day.

Table 8 Market reaction to expected and unexpected earnings

Sample d 0 d 1 d 2 R2 F Obs.

All 0.00437 0.00875 0.01874 0.121 14.13 192(0.28) (3.29) (3.11)

IBEX35 0.0941 2 0.00003 0.01893 2 0.017 0.18 98(1.70) (0.03) (0.55)

Non-IBEX35 0.000007 0.00949 0.0180 0.202 12.81 94(0.011) (3.31) (2.82)

Notes:This table contains the results of the regression of abnormal returns cumulated from day 2 3 today 1 9 on expected changes and unexpected changes in earnings. Expected earnings changes(EEC) are de� ned as (FEPSy 5 0 2 EPSy 2 1)/ * EPSy 2 1 * and unexpected earnings changes (UEC) as(EPSy 5 0 2 FEPSy 5 0)/ * EPSy 2 1* where EPSy is the actual earnings per share for year y and FEPSy

is the last consensus forecasted earnings per share for year y available before the earnings � gurewas disclosed.

CARi 5 d 0 1 d 1(EECi) 1 d 2(UECi) 1 m i


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newer ones. In short, the estimate of unexpected earnings is likely to be� awed. Similar errors are to be found in the non-IBEX35 sample but, asexpected earnings have explanatory power for this group, the inclusion of anelement of expected earnings changes in unexpected earnings is less trouble-some than for the IBEX35 sample.

CONCLUSION

In Spain earnings announcements are accompanied by an increase in shareprice volatility which persists for a few days. The evidence presented in thispaper suggests that volatility is abnormally high for the four days followingthe announcement as well as the announcement day itself and the daypreceding the announcement. This result is not surprising and con� rmsevidence from the US, the UK and elsewhere. The value of this evidence liesin the con� rmation that the relationship between security prices and account-ing information in Spain is as expected – a country which has only recentlyadopted accounting and security market practices which are consistent withthose in the US and UK.

At � rst sight the evidence that earnings announcements are, on average,accompanied by positive returns is more surprising. If we assume thatinvestors have rational expectations of earnings the actual earnings are aslikely to be bad news as good news – in which case negative returns are aslikely as positive returns. Indeed, given the evidence that analysts arenormally optimistic in their forecasts, bad news might be expected todominate. However, positive returns have occasionally been documentedbefore, although only, as far as we are aware, for the US (Chambers andPenman, 1984; Penman, 1984; Ball and Kothari, 1991). The increase involatility and information asymmetry associated with earnings announce-ments might well be expected to increase risk and, if abnormal returns arecalculated without allowing for this increase, positive abnormal returns are tobe expected. Our evidence con� rms this and demonstrates that, in part, theseincreased returns are a function of higher betas. These results also emphasizethe problems associated with estimating the risk–return relationship out ofthe sample and assuming that it holds good for the event window.

Finally, we present evidence concerning the relationship between abnor-mal returns in the event window and expected and unexpected changes inearnings. Such investigations are always circumscribed by the shortcomingsof the earnings expectations model, but consensus analysts’ forecasts areprobably the best available (Fried and Givoly, 1982). For the full sample ourresults suggest that both unexpected and expected earnings are associatedwith abnormal returns but this is almost entirely driven by the results for thesmaller � rms in the sample. That earnings changes, expected or not, havepredictive power for returns is not unheard of (Beaver et al., 1979; Pope andInyangete, 1992; Elsharkawy and Garrod, 1996) but it is interesting to see


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that this phenomenon is apparent in the Spanish market and that it is largelyconstrained to the smaller � rms – presumably due to the in� uence of lesssophisticated investors in the smaller � rms.

ACKNOWLEDGEMENTS

M. J. Arcas has bene� ted from the funding by the Spanish Ministry ofEconomy (Direccion General de Investigacion Cient õ � ca y Tecnica (DGI-CYT), projects PR95-168 and PR95-406).

NOTES

1 Ley 19/1989, de 25 de julio, de reforma parcial y adaptacion de la legislacionmercantil a las Directivas de la Comunidad Economica Europea (CEE) en materiade sociedades.

2 Ley 24/1988, de 28 de julio, del Mercado de Valores.3 For a discussion of thin trading adjustment procedures see McInish and Wood

(1986). However, Ocana et al. (1997), in a study which is likely to be moresensitive to thin trading than the one reported here, � nd that thin tradingadjustments make no signi� cant difference to an event study based on Spanishdata.

4 In order to test this we regressed the returns across the full window against log ofmarket value at the announcement date for the full sample, and the IBEX and non-IBEX subsamples, using the returns from the zero–one model and for the fullavailable window for the IBEX sample using market model returns. In no case didcapitalization have signi� cant explanatory power and in all cases the R2 wastrivial.

5 Volatility was also included as a control variable in separate tests even thoughconventional � nance theory does not propose a link between volatility and returns.Yet evidence reported earlier in this paper shows that volatility changes markedlyduring the earnings disclosure period and naive or undiversi� ed investors may wellsee volatility as an indicator of risk.

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regularities in the equity price response to earnings announcements in spain

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