The Information Content of Annual Earnings Announcements

The information content of earnings is an issue of obvious importance and is a focal point for many measurement controversies in accounting. This paper empirically examines the extent to which common stock investors perceive earnings to possess informational value. The study directs its attention to investor reaction to earnings announcements, as reflected in the volume and price movements of common stocks in the weeks surrounding the announcement date. Valuation theory has long posited a relationship between earnings and the of common stock. Miller and Modigliani postulate that one important element in determining the of common stock is the product of earnings times the appropriate earnings multiplier for that risk class.' Graham, Dodd, and Cottle take a similar position with respect to the computation of their intrinsic value of common stock securities.2 MM also provide empirical evidence that suggests if reported earnings are adjusted for measurement errors through the use of instrumental variables, the adjusted earnings are useful in the prediction of the market of electric utility firms. In fact, the evidence indicated that the earnings term was the most important explanatory variable in the valuation equation.3 The relationship is a necessary condition for earnings to have information content,