Investors have a different overall reaction to earnings news when it is delivered sequentially in two parts, says Jeffrey S. Miller, accountancy professor at the Mendoza College of Business. “Because of the way people cognitively process information, they process it differently if it is communicated in pieces rather than all at once.”
Corporations release pre-announcements, or tentative earnings estimates, weeks or days in advance of the actual earnings report as a strategy to manage market expectations. But the impact on investors of sequencing earnings information may be more complicated than companies expect.
Research has shown that when a company expects a favorable earnings report, communicating part of the news in a favorable pre-announcement and then releasing the reminder of the news in a positive earnings report can elicit an overall stronger positive reaction from investors than waiting to release all of the news in an earnings report, says Miller.
However, disclosing negative earnings news a little at a time results in an overall worse reaction after the report is issued. “If you have bad news, get it all out in the pre-announcement," he says. “Don’t piecemeal it out to investors.”
In his study, “Unintended Effects of Pre-announcements on Investor Reactions to Earnings News,” published in the Winter 2006 edition of Contemporary Accounting Research, Miller found that investors appear to exhibit diminishing sensitivity to earnings surprises. Pre-announcements cause investors to react to the pre-announcement surprise and then the subsequent earnings announcement surprise. As a result, the net effect of these two surprises on investor judgments can be very different from the effect of a single earnings announcement. Further, investors appear to be unaware that their reactions to earnings news are affected by pre-announcements.
“Few firms adopt policies of consistently disclosing pre-announcements, perhaps because of uncertainty about how these disclosures influence analyst and investor reactions to total earnings news,” says Miller.
For more information, visit Professor Miller’s Web site at business.nd.edu/jeffmiller.