Intra-Year Changes in the Earnings-Return Relation: Implications for Examination of Earnings Timeliness

1. Intra-Year Changes in the Earnings-Return Relation: Implications for Examination of Earnings Timeliness Ryan Ball Chicago Booth School of Business&Peter Easton Center for Accounting Research and Education Workshop: University of Texas, Austin September 10, 2010

2. The regression • annual earnings on 252 daily returns • components of annual earnings on 252 daily returns • partition on good news / bad news • estimate earnings/daily returns coefficients • capture proportion of daily price change incorporated in earnings (i.e., change in book value) • generally implicitly assumed to be the same on each day • varying degrees of incorporation of value change (information effects) • may change in predictable ways • from beginning to end of year • on earnings annuncement days?

3. Regression Annual return Net Income Operating Margin Period Expense Daily return Earnings/daily returns coefficient at beginning of fiscal year Earnings/daily returns coefficient at end of year

4. Figure 1 Estimates of net income/daily returns coefficient -0.043 (-3.57) 0.114 (10.28) 0.072 (9.31) 0.091 (11.86) Number of trading Day Relative to First Day of the Fiscal Year, t

5. Basu-Type Analysis 1 if annual return negative 0 otherwise coefficient on negative annual returns earnings/daily returns coefficient at beginning of year if annual return negative earnings/daily returns coefficient at end of year if annual return negative earnings /daily returns coefficient at beginning of year if annual return positive earnings /daily returns coefficient at end of year if annual return positive

6. Figure 2Estimates of net income/daily returns coefficient: Partitioned by sign of returns of the fiscal year 0.158 (12.78) 0.010 (0.67) 0.151 (17.37) 0.148 (13.77) -0.044 (-3.51) 0.073 (5.35) 0.030 (4.53) 0.049 (5.83) Number of trading Day Relative to First Day of the Fiscal Year, t

7. Figure 2Estimates of net income/daily returns coefficient: Partitioned by sign of returns of the fiscal year • no change in coefficient over the year • contrary to prediction • slight upward slope? more timely incorporation of bad news As predicted earnings/daily returns coefficient declines over the year Number of trading Day Relative to First Day of the Fiscal Year, t

8. Figure 1Estimates of net income/daily returns coefficient Decline in earnings/daily returns coefficient is due to positive return observations not negative annual return observations. Why? Number of trading Day Relative to First Day of the Fiscal Year, t

9. Components of Net Income • Operating Margin (i.e., Sales Revenue – Cost of Sales) • Period Expenses (i.e., Net Income – Operating Margin) • Net Income (i.e., Operating Margin – Period Expenses)

10. Figure 3Estimates of operating margin/daily returns coefficient: Partitioned by sign of fiscal year returns 0.354 (4.60) 0.332 (5.19) 0.178 (4.60) 0.035 (0.91) 0.175 (4.21) -0.022 (-0.055) Number of trading Day Relative to First Day of the Fiscal Year, t

11. Figure 4Estimates of period expense/daily returns coefficient: Partitioned by sign of fiscal year returns 0.281 (4.25) -0.275 (-3.43) 0.184 (2.98) 0.130 (3.90) 0.006 (0.15) -0.365 (-5.77) 0.025 (0.62) -0.186 (-3.96) Number of trading Day Relative to First Day of the Fiscal Year, t

12. Components of Period Expenses • Related to sales of the year (Sales Expenses) • Related to expectations of change in profitability in future years (Other Expenses) • If annual returns are negative (i.e., net bad news) • Sales expenses positively related to returns • i.e., worse (more negative) returns, lower expenses • Other expenses (e.g., assets write-downs) negatively related to returns • i.e., worse (more negative) returns, greater expenses

13. Figure 4Estimates of period expense/daily returns coefficient: Partitioned by sign of fiscal year returns No expenses related to expectations of future profitability Expenses related to sales of the year Expenses related to expectations of future profitability Number of trading Day Relative to First Day of the Fiscal Year, t

14. Figure 4Estimates of period expense/daily returns coefficient: Partitioned by sign of fiscal year returns 0.281 (4.25) -0.275 (-3.43) 0.184 (2.98) 0.006 (0.15) -0.365 (-5.77) -0.186 (-3.96) Number of trading Day Relative to First Day of the Fiscal Year, t

15. Earnings Announcement Dates

16. Figure 5Estimates of net income/daily returns coefficient: Controlling for incremental changes at quarterly earnings announcement dates 0.091 (9.96) 0.096 (10.63) 0.086 (7.58) 0.055 (5.68) 0.114 (10.28) 0.101 (9.15) 0.071 (7.21) 0.064 (5.20) Number of trading Day Relative to First Day of the Fiscal Year, t

17. Earnings Announcement Dates: Positive and Negative Annual Returns

18. Figure 6Estimates of net income/daily returns coefficient Controlling for incremental changes at quarterly earnings announcement dates: Partitioned by sign of fiscal year returns 0.158 (10.39) 0.148 (9.72) 0.140 (9.21) 0.151 (9.99) 0.073 (5.35) 0.061 (4.51) 0.029 (2.47) 0.023 (2.22) Number of trading Day Relative to First Day of the Fiscal Year, t

19. Control for Change in Variance

20. Figure 7Standard deviation of daily returns: Unconditional and partitioned by sign of the fiscal year returns Number of trading Day Relative to First Day of the Fiscal Year, t

21. Figure 8Estimates of net income/variance-adjusted daily returns coefficient Number of trading Day Relative to First Day of the Fiscal Year, t

22. Summary 0.354 0.332 Operating Margin (-) Operating Margin (+) 0.035 0.022 0 252 Number of trading Day Relative to First Day of the Fiscal Year, t

23. Summary 0.281 Period Expense (+) 0.184 0.006 0 252 Period Expense (-) -0.186 Number of trading Day Relative to First Day of the Fiscal Year, t

24. Summary 0.354 0.332 Operating Margin (-) 0.281 Operating Margin (+) Period Expense (+) 0.184 0.158 0.148 Net Income (-) 0.073 0.035 0.030 0.022 0.006 0 252 Net Income (+) Period Expense (-) -0.186 Number of trading Day Relative to First Day of the Fiscal Year, t

25. Summary • net income/daily returns coefficient declines from beginning of year to end • much of the difference between the net income/daily returns coefficient for negative annual return observations vis-à-vis positive annual return observations is due to other expenses • much more of the value change on earnings announcement days is captured in earnings of the fiscal year when compared with value change on other days