This document is a dissertation submitted by a student at the University of Southampton in 2014/15. It examines the relationship between earnings announcements and share returns, replicating the seminal study by Ball and Brown from 1968. The dissertation consists of an introduction outlining the topic and motivation, a literature review on market efficiency, information content of earnings, and Ball and Brown's 1968 study. It then describes the methodology used, including sample selection from 2009-2013, data collection, analysis plan and ethical considerations. The document outlines the structure for presenting results, analysis, limitations and conclusions.

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The University of Southampton
2014/15
Faculty of Business, Law, and Arts
School of Management
MANG3025 Dissertation
Capital Markets and Earnings Announcements: The Earnings-Share
return relationship revisited
Student Registration Number: 25231634
Presented for BSc. Accounting and Finance
This project is entirely the original work of student registration number
25231634. Where material is obtained from published or unpublished
works, this has been fully acknowledged by citation in the main text and
inclusion in the list of references.
Word Count: 7150

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Table of Contents:
Chapters Pages
Reference
1. Acknowledgement 3
2. Abstract 3
3. Introduction 4
4. Literature Review 6
a. Market Efficiency 6
b. Information Content of Earnings 8
c. Ball and Brown (1968) – An Empirical Evaluation
Of Accounting Income Numbers. 11
5. Methodology 13
a. Sample Selection 13
b. Data Collection 15
c. Data Analysis 15
d. Ethical Implication 18
6. Results and Analysis 18
a. Association between Earnings Announcements
and Share Returns 18
b. Limitations of the study 24
c. Possible remedies 24
7. Concluding remarks 25
8. References 27

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Acknowledgement
A thank you must be extended to my dissertation supervisor, Dr
John Maligila, for his assistance while undertaking the task of this
study.
Abstract
Over the years, the relationship between reported annual earnings
and share returns has seen a vast amount of theory and empirical
evidence been developed. As well as shedding light on other areas
such as Market efficiency and the informational value of earnings
announcements. This paper, seeks to further understand this
relationship, particularly the association between the sign of
earnings change and the direction of the share return (positive or
negative). By examining data from 2009 to 2013, the study aims to
replicate the results of Ball and Brown (1968) focussing on the 30
days immediately after the announcement of the earnings reports.
The study draws on prior literature such as Beaver (1968) and
Fama (1970) to explain how informational value of earnings and
market efficiency impacts on earnings announcements and share
returns. This study by no means looks to extend the theory and
evidence of Ball and Brown (1968). However, it will look at the
application of the theory into the modern day capital markets.

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Introduction:
Accounting data is part and parcel in the decision making process for
investors and has been for many years. Whether they are assessing a
firm’s liquidity, trying to predict the long term prospects of a firm or as a
benchmark for comparison. Accounting figures tend to be the first port
of call in this process, ultimately resulting in the investor assuming a
long, short or hold position. Hence accounting theorists, regulators and
policy makers have for many years tried to development an all-
encompassing conceptual framework for financial report makers to use
as a guide. The rationale, is based on the fact that standard setters
want investors to be able to make more informed decisions as to the
allocation of their resources (wealth) based on the accounting data
available to them (Financial Reporting Council, 2009).
Academics have devoted a large amount of time to documenting the
reaction of investors to accounting data, and more importantly, how this
data impacts on the capital markets. The latter leads onto the purpose
of this study, as implied by the title the objective is to examine the
relationship between earnings (more precisely net income) and share
returns (a definition can be found in the Data Analysis section of the
methodology chapter, page x). The term ‘revisited’ implies that this is
not an area of study that has only recently been looked into, and this
study is by no means breaking new ground. On the contrary, the
earnings – share return relationship has been of particular interest to
academics for some time, Ball and Brown being such academics. Their
paper – An Empirical Evaluation of Accounting Numbers (1968)
documented the relationship like no other before them and ever since
academics have replicated the study in order to further understand the
relationship.
Why are the findings of Ball and Brown (1968) significant? As
described by Nichols and Wahlen (2004, p264) the study ‘…triggered a
shift in the accounting research paradigm.’ Prior to Ball and Brown

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(1968), accounting research was largely concerned with theoretical
analysis as opposed to empirical. (Nichols and Wahlen, 2004)
This study looks to replicate that of Ball and Brown (1968), with the use
of data from the London Stock Exchange (exclusively FTSE100 firms)
as compared to the New York Stock Exchange. The study will be
looking at data from 2009 through to 2013. By looking at this period in
particular, which falls directly after the global financial crisis of 2008,
the study aims to ascertain if the findings are fundamentally altered as
a consequence of the crisis. As Ball and Brown’s study took place over
50 years ago, differences are expected but by in large the underlying
results are expected to still be the same.
The study looks at the association between net income and share
returns, specifically does good earnings reports translate to a positive
share return and is the opposite true for poor firm performance. The
following quote taken from Beaver (1968), raises the issue of the
informational value of earnings figure:
‘…the question of concern is not whether investors should react to
earnings but rather whether investors do react to earnings.’ (Beaver,
1968 p68)
Leading on from this statement it can be said that if investors’ perceive
a piece of information to be worthless then it will not be acted upon.
With the opposite being true for information of value. (Ball and Brow,
1968) The reason for mentioning this is down to the fact that this study
assumes that earnings announcements possess informational value
and that this is key to observing the expected results (Further
discussion is found in the literature review, page 6). Findings from the
study conducted by Nichols and Wahlen (2004) suggested merely the
sign change of earnings is associated with an average difference of
35.6 percent in abnormal annual returns. In comparison to Ball and
Brown (1968) reported a difference of 16.8 percent. Nichols and Brown
(2004) conducted similar test on the use of operational cash flow,
however the results showed that more value-relevant information was

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contained in earnings figures as compared to operational cash flows.
That being said, the results reinforce the consequences of earnings
information for share prices, and sheds light on why market participants
devote a large amount of resources to forecast earnings. (Nichols and
Wahlen, 2004)
The motivation behind the choice of topic, really stems from an avid
interest in the relationship between financial accounting information
and how it affects capital markets. With a plan to pursue a career in the
financial sector, this study will aid in developing my understanding of
the current theory and empirical evidence pertaining to this field.
The paper is structured in a manner that sets out to build theory on the
relationship between earnings and share returns from past literature.
Looking at the assumptions made and discussing the empirical
evidence that supports these assumptions. In particular, discussing in
brief Market efficiency and the role it plays in capital markets, delving
into the background of informational value of earnings and then
exploring the theory and findings of Ball and Brown (1968). The
chapters following on from that layout the methodology used to conduct
the study, presentation of the results and how they compare to that of
Ball and Brown (1968) and other prior studies and lastly concluding
remarks, discussing limitation to the findings as well as possible
avenues for further study.
Literature Review
Market Efficiency
Market efficiency refers to the range of information that prices reflect,
considering the rate at and degree of completeness, with which the
capital markets react. (Nichols and Wahlen, 2004) Fama (1970) defines
an efficient market as one in which the market prices “fully reflects”
available information. Market efficiency is not absolute (Nichols and
Wahlen, 2004), the term “fully reflects” has no clear cut definition – so
what constitutes a full reflection of available information is difficult to

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nail down. (Fama, 1970) As Nichols and Wahlen (2004, p269) so
eloquently describes it, “…market efficiency is a matter of degree…”
Thus efficiency is classified into different levels depending on the
nature of the information subset. (Fama, 1970) Namely; Weak form,
semi-strong form and Strong form. Weak form efficiency implies the
market “fully reflects” all historic prices and returns. It is largely
encompassed but the Random Walk Theory, which states that price
changes are all independent of one another. A semi-strong form
efficient market will react to all obviously publicly available information
– earnings announcements, stock splits, dividend announcements, just
to name a few examples. The random walk theory is also apparent at
this level of efficiency, in theory of course, given the random nature in
which this information reaches the market. Strong form efficiency
encompasses both weak and semi-strong form efficiency whilst it also
factors in information that may not be publicly know. In other words it
prevents individual investors or groups from exploiting monopolistic
information sources. (Fama, 1970)
What role does market efficiency play in the context of this study? The
assumption here given the theory holds that once the net income
figures are made public, capital market participants have the incentive
to react to the announcement completely, thus ensuring no abnormal
returns can be earned consistently, once the announcement has taken
place (Nichols and Wahlen, 2004). Evidence from Ball and Brown
(1968) supports this theory, approximately 10 to 15 percent of the
information value contained in reported net income is not anticipated by
the month in which it is made public, resulting in no opportunity for
abnormal profits. In other words the findings were consistent with the
evidence that the market react to the data without bias. (Ball and
Brown, 1968) Contrary to these findings Fama (1970) suggests that
important information – such as the unexpected element of earnings –
cannot be evaluated immediately, however the first day’s adjustment
still seems to be unbiased. Results taken from Nichols and Wahlen
(2004) paint a similar picture, the market fails to react immediately to

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the new information contained in the earnings reports and abnormal
returns are still present for some time. The anomaly described is
referred to as “post-earnings announcement drift”, it is a puzzling
anomaly and has received much debate. One possible explanation
being the lack of consensus amongst investors as a result of new
information. (Beaver, 1968)
Information Content
Referring back to the introduction of the paper, the issue pertaining to
the informational value of earnings was raised. It has been of much
contention over the year, whether or not earnings data as presented by
earnings announcements exhibits informational value. Speculators
have been of the opinion that income numbers, specifically, were
meaningless and did not provides useful insights. Below are some of
the points raised by researchers on this matter.
‘Because accounting lacks an all-embracing theoretical
framework, dissimilarities in practises have evolved. As a
consequence, net income is an aggregate of components which
are not homogenous. It is thus alleged to be a “meaningless”
figure…’ (Ball and Brown, 1968 p.160)
William Beaver’s paper - the information content of annual earnings
announcements, identified a couple of positions adopted by investors
as to explain why it was thought income numbers did not possess
informational value. Firstly, the measurement errors associated with
earnings were so large that it would be better to estimate the value of
common stock directly from instrumental variables rather than through
the use of earnings. The second point raised by Beaver focused more
on the timeliness of the earnings, however conceding that earnings
data does in fact possess to some degree informational value but goes
on to say that there are other sources available to investors that
contain essentially the same information but are timelier. (Beaver,
1968)

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In other words, by the time annual income figures are released, any
information content has already been accounted for by investors and is
reflected in the market price. (Beaver, 1968) This has been reiterated
by Nichols and Wahlen (2004), suggesting more timely mediums are
available to investors and so annual income numbers are of little use.
While there is a lot of evidence to suggest that earnings figures carry
little significance, there is also a vast collection of literature which
implies the contrary. The information content of annual earnings
announcements (Beaver, 1968), is one such paper that looked to
address this apparent grey area. In the context of earnings
announcements, they are deemed to possess informational value if it
results in a change in investor’s assessments of the probability
distribution of future returns, causing a change in the equilibrium value
of the current market price. (Beaver, 1968). Based on the definition of
information used by Beaver in the context of his study, we expect to
see the variability of stock prices being greater around the
announcement date as compared to the rest of the year. (Beaver,
1968)
The study itself looked at the period from 1961 to 1965 (relatively short
in contrast to studies such as Ball and Brown (1968), Nichols and
Wahlen (2004), and King. (1966)) to which his sample consisted of 143
firms resulting in 506 observations. Unlike the paper by Ball and Brown
(1968) which will be discussed further on in the paper, Beaver only took
firms whose fiscal year ended on a date other than December 31st.
(Beaver, 1968)
Why is this particular criterion important? Firstly it cuts out a large
amount of the sample population and allows for easier analysis of the
variables, with a year end in December, firms would see their annual
announcements taking place in the months of February, March and
April resulting in a large clustering effect (Beaver, 1968). To add to this
Ball and Brown (1967) found that on average 35 to 40 percent of the
variability of a firm’s annual earnings is associated with the variability of
earnings numbers averaged over the market, and that a further 10 to

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15 percent can be attributed to industry averages, these findings are
further supported by King (1966) who identified similar statistics for
stock variability. With this criterion in place, the ambiguity associated
with the observed reactions in the week of the earnings announcement
is reduced (Beaver, 1968). Thus the effect that market and industry
wide factors have, are minimized.
By observing both share price reactions and volumes traded, Beaver
was able to test for information content but also tested the efficiency
with which the market reacted to the announcements. The findings that
Beaver observed were not unsurprising, with respect to volumes
traded. The evidence indicated a dramatic increase in volume in the
announcement week (Week 0). With the mean volume in week 0 being
approximately 33 percent higher than that witnessed during the non-
reporting period (Beaver, 1968)
The share price reaction was analogous to that of volume, where the
highest share price reactions were observed during the announcement
week (Week 0). While the findings for share price and volume were
very similar, it is worth noting that in the weeks prior to the earnings
announcements volumes traded are below normal, while stocks
experience abnormal price changes in the week immediately prior to
the announcement week. (Beaver, 1968) Immediately after the
earnings announcements, price and volume both experience above
normal reactions but are smaller in size compared to the reactions
observed in week 0. Price only experienced above normal activity for
two weeks post announcement while volume was more persistent
where 4 weeks of abnormal activity was observed. (Beaver, 1968)
Relating this back to market efficiency, the abnormal activity shown by
volume implies that market participants are quick to react to the new
information but the reaction is not “complete” as stocks still experience
abnormal returns post announcement date. (Beaver, 1968) Which
suggests the market is not fully efficient. However proves that earnings
reports still possess information of value at the time of their
announcement and for some time after.

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Ball and Brown (1968) Empirical Evaluation of Accounting Income
Numbers
Before delving into the theory and evidence presented by Ball and
Brown, here is a brief overview of their study. Their sample consisted of
firms that were listed on the New York Stock Exchange and drew data
from 1944 through to 1966. However their analysis was limited to the
period of 1957 to 1965, resulting in 10 observations and a sample size
of 261 firms. (Ball and Brown, 1968) Their study developed on the
research conducted by Beaver (1968), by constructing two expectation
models (regression model and naïve model) Ball and Brown were
trying to pin point what effect the sign of the forecasting error of
earnings (difference between the actual and expected earnings) had on
the direction of the share price change around the earnings
announcement date.
The regression model, used a regression formula to determine the
expected net income variables (net income and earnings per share) for
the sample, while the Naïve model took the expected net income
figures to be same as the previous years reported earnings (further
explanation of the Naïve model can be found in the methodology
chapter, page x). Some of the evidence from Ball and Brown (1698)
has already been discussed in previous sections of this paper, this next
section will highlight the important conclusions of their paper.
Much of the theory that existed prior to conducting the study showed
that a vast portion of the information content reflected in the earnings
announcements was anticipated by investors before the
announcements took place. (Beaver, 1968) This was the case, Ball and
Brown reported similar findings – in the months leading up to the
earnings announcements, the firms showed abnormal share returns for
12 months preceding the announcement date but did so with an
increasing success over the 12 months. (Ball and Brown, 1968) I.e. the
abnormal returns got larger as the announcement day drew nearer.
While abnormal returns persist for some time after the announcement

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date, as a consequence of the anticipation of earnings information –
Ball and Brown (1968) found that approximately 10 to 15 percent of the
informational value contained within the earnings reports is new
information – the abnormal share returns post the announcement day
are less pronounced than those observed pre-announcement.
The persistence of the abnormal returns is somewhat contrary to
market efficiency theory, while there is no clear cut reason for this
phenomenon Ball and Brown do suggest is could be attributed to
random errors in the announcement dates., this reasoning could be
ruled out as the announcement dates were obtained via the Wall Street
Journal Index were confirmed. Thus, the only other reasoning suggests
that preliminary results are not viewed to be final, so investors wait until
the annual reports are released before acting. (Ball and Brown, 1968)
Other findings include, the similarity of results between net income and
earnings per share (EPS). (Ball and Brown, 1968) Though, a gap does
appear post-announcement but there is nothing significant to be drawn
from this.
Nichols and Wahlen (2004) replicated Ball and Brown’s research, with
some adjustments to the sample period and size (period: 1988-2001).
Nichols and Wahlen (2004) observed that firms with positive earnings
changes (Good News) experienced average abnormal returns of 19.2%
in the 12 months prior to the announcement date, while firms with
negative earnings changes (Bad News) experienced average abnormal
returns of -16.4% over the same time frame (a difference of 35.6 %).
Contrast with Ball and Brown (1968) findings, firms with positive
earnings changes showed abnormal returns of 7.1% and while firms
with negative earnings changes showed abnormal returns of -9.3% (a
difference of 16.4%). (Ball and Brown, 1968)
The difference in findings is not a cause for concern and a number of
factors can be attributed to this; different sample periods, Nichols and
Wahlen having access to better data regarding the exact day in which

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earnings are announced as well as the use of a different earnings
measure. (Nichols and Wahlen, 2004)
Methodology
As mentioned in the introduction section of this paper, the study is
trying to replicate that of Ball and Brown (1968), the objective of their
study “was to assess the usefulness of existing accounting income
numbers by examining their information content and timeliness.” (Ball
and Brown, 1968) While the quote encompasses the vast majority of
what Ball and Brown were trying to achieve, their work expanded on
that done by Beaver (1968) by implement an expectations model in
order to identify the direction of the share reaction synonymous with the
change in net income figures from year to year. While I shall still be
adopting some of their technics and selection criteria for the data set,
my methods shall take a simpler and less time consuming approach in
order to safe guard against the time constraints associated with the
study.
Selection of Sample.
Three classes of data will be of interest: the content of the financial
reports (the net income figures themselves); the dates at which the
reports are made public (preliminary announcements); and finally the
share price movements post announcement dates. (Ball and Brown,
1968) The following criteria was used in determining the sample firms,
it is largely adapted from Ball and Brown (1968) with a few adjustments
tailored to fit this study’s time constraints:
1. The firms must be a FTSE100 index firm, i.e. be listed on the
London Stock Exchange (LSE).
2. The firms’ fiscal year must end on the 31st of December
3. Preliminary earnings announcements are available through RNS,
PRNewswire, Hugin or any other regulatory news publications.
4. The firms have to been listed on the LSE for the duration of the
sample period, 2009-2013.
5. Firms’ main listing must be the LSE.

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In contrast to Ball and Brown (1968) and Nichols and Brown (2004)
(who selected firms listed on the New York stock exchange) the
purpose of criterion 1, is to see if firms in different countries confirm to
the same reactions. Additionally, the data for FTSE100 firms is more
readily available and allows for a smaller sample of firms to look at.
Criterion 2 and 3 are to keep consistency with Ball and Brown, the
reasoning behind the use of preliminary results as eluded to by Ball
and Brown (1968), is based on the fact that preliminary
announcements are the first official release of information by firms and
the figures reflected in the preliminary announcements are more often
than not the same as the final audited figures found in the Annual
reports. Criterion 4 helps to ensure the sample is consistent and
reduces any confusion as a result of additional observations in the
latter years of the sample period. As a consequence of this two firms
were removed from the sample. Would this incur any bias? The sample
size given the listed criteria, accounts for just over 50% of the firms that
make up the FTSE100 index, so the results would be largely
representative for the rest of the index. The FTSE100 is comprised of
the 100 most highly capitalised blue chip companies listed on London
Stock Exchange. (http://www.ftse.com) With an average total net asset
value, for the index, of £25,752.7 million and £36,687.1 million for the
sample firms. Concern over the bias being induced by the sample
firms’ size is warranted as stated by Beaver (1968), larger firms tend to
release more information than smaller firms. But as the study is looking
at FTSE100 firms in isolation, the results expected should still mirror
those of Ball and Brown (1968) and Nichols and Wahlen (2004).
All firms that make up the FTSE100 index have listings on a number of
other stock exchanges, so excluding firms that had multiple listings
would make no logical sense. However, a majority of the firms have the
London Stock Exchange as their main listing. Criterion 5 seeks to
remove any firms that do not have the LSE as their main exchange
listing, the purpose for this is to remove any effect that announcements
from foreign exchanges have on the sample.

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Data Collection
As mentioned previously the sample has been drawn from firms that
make up the LSE FTSE100 index, applying the selection criteria has
resulted in the sample set consisting of 52 firms. A list of firms before
and after applying the selection criteria can be found in the appendix. I
used the FAME database to obtain a list of the firms that made up the
FTSE100 index, the list of firms was verified through cross examination
with information obtained from the London stock exchange website as
well as the FTSE indices website. The rationale behind the use of
FAME, is put down to the fact that all the data - list of firms, net income
figures, year-end dates and the firms’ total net asset values were
available from this one source, bar the preliminary announcement
dates and the daily share prices for each year. Morningstar Company
Intelligence – a database tool which houses financial data for firms
listed in the UK and Ireland, as well as a collection of regulatory
publications – was used to collect all the required preliminary
announcement dates needed for the study. Daily share price figures for
the sample period were obtain through the use of DataStream, as will
be mentioned in the analysis section, the study is looking at the share
price reactions for the 30 days after the announcement dates. This
means 30 trading days rather than the conventional calendar month
(i.e. weekends are excluded).
Data Analysis
Before describing the processes of data analysis some definitions - that
are needed to understand the terminology used, are listed below.
Net Income – The definition used here is taken from that of Ball and
Brown, (1967), this definition was used by Ball and Brown (1968) to
define their earnings variable. Net income is the income after all
operating and non-operating income and expenses and minority
interest but before dividends. (Ball and Brown, 1967)
Total Net Assets – This the value of the firms total assets, both Non-
current and current which is net of current liabilities.

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Share Return – This refers to the percentage increase or decrease in
the price of the stock. A positive share return would be the result of an
increase/appreciation in the price/value of a stock, while a negative
return is the result of a decrease/depreciation in the price/value a stock.
The first step in the analysis process is to develop an expectations
model in order to predict the direction of the share return (i.e. will it be
positive or negative). (Beaver, 1968) Going along with the approach
taken by Ball and Brown (1968), the sample is divided into two groups:
Firms that displayed results that are perceived as ‘Good News’ and
firms that displayed results that are perceived as ‘Bad News’. In each
year of the sample the firms will be pooled into each group based on
their performance as measured by net income, so firms many not
always be in the same group for the entire sample period and will more
than likely switch between the groups over the period.
Good News is as a result of a firm’s actual net income being greater
than the expected income (AI – EI > 0). While Bad News is the
opposite, Actual Income is less than Expected Income (AI – EI < 0).
Expected income in the context of this study is the net income figure for
the previous year. I.e. a Naïve model is adopted however Ball and
Brown (1968) used EPS for the naïve model variable and not net
income.
Example. If firm A reports a net income to its shareholders of £1.5
million in 2009, and the net income for 2008 was £1.25 million. The
expected net income for 2009 is £1.25 million. So £1.5 - £1.25 = £0.25
million which is greater than zero and hence would be grouped in the
good news category.
The next step is to calculate the share returns for each firm, on a daily
basis for the 30 days after the preliminary announcement date, day 0
(as previously stated it is 30 trading days and not a normal calendar
month).

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Mathematically speaking:
RiT = (Pt – Pt-1)/Pt-1
Where:
RiT is the return on stock I;
Pt is the Price of stock i at time t, and;
Pt-1 is the Price of stock i at time t-1.
As an example if time t was day 1 then, t-1 would be day 0.
The above equation is also used to determine the contemporaneous
return for the market index (FTSE100), the values for the stock price
are replaced with the corresponding index value. Why is the return for
the FTSE100 required?
Under the assumption made by Ball and Brown (1968), in the absence
of useful information during a period, the rate of return would only
reflect the presence of market wide information. In other words, the
stocks’ returns would resemble that of the market. Thus, by abstracting
the market effects, the return associated with firm specific information
(net income) can be isolated.
The following formula attempts to achieve this:
ARi,T=Ri,T-RM,T
Where:
ARi,T - is the abnormal return for stock i during period T, assumed to be
as a result of the firm specific information.
Ri,T – is the total return for stock i, during period T
RM,T – is the return for the market index during period T.
By using the above formula, the abnormal returns for each firm on day
0 through to day 30 can be calculated. This is repeated for each year of
the sample period. Following on from this, the next objective is to
cumulate the abnormal returns for the two groups (Good news and Bad
news) over the 30 day period post announcement. The results are then

18. 18
summarize by averaging out the cumulative abnormal return for each
day across the sample period (Nichols and Brown, 2004), 2009-2013.
Ethical Issues
The study is in effect a replication of that conducted by Ball and Brown
(1968), and hence the methodology and data used to analyse the
proposed hypotheses are all from secondary data sources (FAME,
DataStream and relevant literature). I submitted the ERGO application
form along with the relevant risk assessment form on the 16th February
2015, which was reviewed and approved by the Ethics Committee by
the 23rd of February 2015.
Results and Analysis
Association between Earnings Announcements and Share Returns
The first part of the study is to test that earnings and share returns are
in fact associated. As outlined in the data analysis section under the
Methodology chapter this was conducted by: first determining how
actual earnings compared to expected earnings, firms’ whose actual
earnings exceeded their expected exceeded were classified as “Good
News” firms and firms’ whose actual earnings were less than their
expected earnings were classified as “Bad News” Firms. The next step
involved calculating their cumulative abnormal returns for the days 0 to
+30, the cumulative abnormal returns was then cross referenced with
their classification (Good news or bad news). Resulting in a Positive
association observation or a negative association observation. Table 1
summarises the observations from the study sample.

19. 19
Table 1.
Observations of Association for the Sample Period
Positive
Association
Observations
(Na)
Negative
Association
Observations
(Nb)
Total
Observations
2009 31 21 52
2010 25 27 52
2011 28 24 52
2012 36 16 52
2013 23 29 52
Sample Period
Total 143 117 260
With this data, the Goodman-Kruskal Gamma Coefficient can be
calculated:
Γ = (Na – Nb) / (Na + Nb)
Γ = (143 – 117) / 260
Γ = 0.10
The coefficient of 0.1 implies that there is a very weak but positive
association between Earnings and share returns. However, a figure
such as 0.1 on the scale develop by Goodman – Kruskal is of little
significance.
Why is the association depicted in this study a weak one? There are a
few factors that could have resulted in the observed outcome.
Inefficiencies in the market could have meant that the market did not
react to the earnings information in typical fashion. The sample size
could not be representative of the rest of the market, also linked to this,

20. 20
by looking at an index in isolation rather than using data from other
London stock exchange indices the results seemed to have suffered
from bias. By focussing on a snapshot of the original test period as
used by Ball and Brown (1968), information that is vital to determining
the association between earnings and share returns is overlooked.
However, this is only 1 of the ways to test the relationship, the next
section analyses the cumulative abnormal returns of Day 0 to Day 30
averaged over the sample period. As outlined in the methodology, the
data is split into two groups, one is made up of firms that showed
positive earnings changes (the Good News group) and one is made up
of firms that showed negative earnings changes (the Bad News group).
Table 2 and Figure 1 shows the results.
For the time being the focus will be on Figure 1 as it offers more of an
insight on face value than the figures in table 2.

21. 21
Table 2.
The Association between Annual Earnings Changes and
Cumulative Abnormal Returns.
Cumulative Abnormal
Returns for “Good News”
Group:
Cumulative Abnormal
Returns for “Bad News’
Group:
Days Relative
to
the Earnings
Announcement
s
Positive
Earnings Changes
Negative
Earnings Changes
Day 0 0.370% 0.023%
Day 1 0.211% -0.197%
Day 2 0.485% -0.370%
Day 3 0.510% -0.467%
Day 4 0.591% -0.424%
Day 5 0.505% -0.427%
Day 6 0.442% -0.499%
Day 7 0.385% -0.668%
Day 8 0.501% -0.840%
Day 9 0.505% -1.123%
Day 10 0.517% -1.071%
Day 11 0.594% -1.068%
Day 12 0.622% -1.110%
Day 13 0.747% -1.059%
Day 14 0.642% -0.975%
Day 15 0.737% -0.952%
Day 16 0.675% -0.927%
Day 17 0.787% -0.799%
Day 18 0.879% -0.740%
Day 19 0.963% -0.639%
Day 20 1.062% -0.532%
Day 21 1.012% -0.618%
Day 22 1.150% -0.741%
Day 23 1.221% -0.607%
Day 24 1.087% -0.826%
Day 25 1.070% -0.787%
Day 26 1.004% -0.991%
Day 27 0.876% -1.065%
Day 28 0.798% -1.037%
Day 29 0.679% -1.308%
Day 30 0.834% -1.449%
The first point of note is the general conclusion that can be drawn from
the graph, the observations seem to suggest– unlike the Goodman-
Kruskal Gamma coefficient – that there is an apparent association

22. 22
between share returns and earnings as indicated by an the cumulative
abnormal return of 0.834% for “Good News” firms and
Figure 1.
The Association between Annual Earnings
And Cumulative Abnormal Returns.
a value of -1.449% for “Bad News” Firms. How do these figures
compare to those of Ball and Brown (1968) and Nichols and Wahlen
(2004)? As this study only looks at the daily effect for a 30 day period
post announcement, then it makes no logical sense to compare it with
returns pre-announcement as observed by the other papers. For the
month after the announcement Ball and Brown (1968), saw “Good
-0.02
-0.015
-0.01
-0.005
0
0.005
0.01
0.015
Day 1Day 3Day 5Day 7Day 9 Day
11
Day
13
Day
15
Day
17
Day
19
Day
21
Day
23
Day
25
Day
27
Day
29
CummulativeAbnormalReturns
Days relative to the Earnings Announcement
Positive Earnings Changes Negative earnings Changes

23. 23
News” firms experience abnormal share returns of 0.4% and “Bad
News” firms recorded a value of -0.6% (difference of 1.0%) . While
Nichols and Wahlen (2004) recorded values of 1.3% and -0.5%
(difference of 1.8%) for “Good News” and “Bad News” firms
respectively. Compared with the figures of this study “Good News”
firms showed cumulative abnormal returns over the 31 days (including
day 0) of 0.834% and -1.449% cumulative abnormal returns for “Bad
News’ firms, a difference of 2.283%. These results are consistent with
Ball and Brown (1968) in the context that the abnormal returns are
seen to persist throughout the 30 days after the announcement day.
While this study has only focused on the earnings-share return
relationship from a post-announcement perspective, under the
assumption that the pre-announcement abnormal returns behave in a
similar manner to those of Ball and Brown (1968) as well as Nichols
and Wahlen (2004), then the results indicate that while the market may
have anticipated and reacted quickly to earnings information, the
reaction is not complete and thus implying “post-announcement drift” is
apparent. (Nichols and Wahlen, 2004) However, as the study has not
examined the association from the preannouncement perspective,
reading further into the “findings” must be done with a fair amount of
scepticism.
According to Beaver (1968), the greatest abnormal returns should be
observed during the announcement week, while the results for “Good
News” firms supports the evidence, “Bad News” firms are slow to react
with abnormal returns on Day 0 being positive rather than negative as
anticipated. This may be as a result of a strong majority of FTSE100
firms posted positive share returns and so the “Bad News” firms’
returns are dragged up as a result. By using a market return model, the
possibility the bias is due to this is high.
Beaver (1968) also found that the abnormal share returns persist for
two week post announcement and then revert back to equilibrium. In
the first two weeks, “Good News” firms had a cumulative abnormal

24. 24
share return of 0.642% and “Bad News” firms had cumulative abnormal
returns of -0.975%. Contrast this with the returns from the end of the
second week till day 30 (“Good News” firms = 0.192%, “Bad News”
firms = -0.474%). It is evident that in the latter part of the 30 day period
the abnormal returns start to dissipate.
Limitations associated with the Study
Based on the results depicted, it is pretty clear as to some of the
limitations of this study and some of which have already been briefly
touched on. The first and possibly the most obvious limitation is as a
result of only looking at the earnings-share return association from the
post-announcement perspective, thus overlooking information that is
relevant to determining the association. More specifically by excluding
the preannouncement period, the association depicted in this study is
very weak compared with Ball and Brown (1968) or with Nichols and
Wahlen (2004). The lack of diversity with respect to the inclusion of
firms may have caused the results to incur bias towards large firms and
hence the results could not be representative of the general populous
that made up the London Stock Exchange. The use of only one net
income variable resulted in a limited scope for comparison.
Possible Limitation Remedies
The limitation mention in the above section, are not all that complex
however to have comparatively large implications on the findings. The
remedies for the limitations are relatively straightforward, as a matter of
consistency the remedies are referred to in order that the limitations are
set out above.
The earnings – share return association is largely dependent on the
informational value tied to the earnings announcement, and as
investors are able to estimate with a high degree of accuracy by the
time the earnings announcement takes place only a small portion of the
informational value associated with earnings has not been accounted
for by the market. (Ball and Brown, 1968) The being said to effectively

25. 25
assess the association of earnings and share returns the analysis must
include periods before the announcement, so in the context of this
study examining abnormal share returns daily from 30 days before the
announcement (day 0) to 30 days after the announcement day. Thus
making the results more representative of the relationship.
To correct for the exclusivity of the sample, expanding the selection
pool to include the FTSE250, FTSE350, FTSE small cap indices
ensures that the sample consists of a range of firm sizes. To aid the
comparison of the results by examining the abnormal share return with
the use of earning per share as a measure of net income.
Concluding Remarks
The initial aim of this paper was to review the earnings-share return
relationship as described by Ball and Brown (1968), by examining the
informational value of the earnings reports and testing whether the
market reacted to this new information. For this to be possible,
assumption were made as to the manner in which the market behaved.
Market efficiency sets out to ensure that all value relevant information
is reflected in the market price in a quick and complete manner, that is
the market should adjust in a way that does not allow for abnormal
profits to be made. (Fama, 1970)
Annual earnings announcements as a timely medium leaves much to
be desired, approximately 85 to 90 percent of the information reflected
by the annual earnings is captured by more prompt channels – interim
accounts being one possibility. (Ball and Brown, 1968) However, the 10
to 15 percent of information contained in the earnings announcements
that is not anticipated, must still be reflected by the market, in
accordance with market efficiency the prices react quickly to the new
information however, this reaction is not complete and so abnormal
share returns are present – this phenomenon is known as “post-
announcement drift” which still vexes a large number of academics to
date (Nichols and Wahlen, 2004). While there is no clearly defined

26. 26
reason as to why this occurs, one possible explanation includes the
fact that investors are unsure are to the relevance of the earnings
information and so do not act upon it until they can confirm it with other
sources most notably the annual reports. As described by Beaver
(1968), investors are unable to reach a consensus.
The replication of Ball and Brown (1968) supported much of the
empirical evidence and theory that pre-existed and as shown by the
association between earnings and share returns the underlying results
are fundamentally consistent. However, as the scope of the analysis
was very narrow drawing definite conclusions must be done so at
discretion and with a high degree of scepticism.
While there are endless possibilities as to further study, in line with
Beaver (1968) a possible avenue of exploration could be the
information content demonstrated by the time lag (time it takes for the
annual results to be made public after the end of the fiscal year) – does
bad news take longer to reach the market than good news? In light of
the upcoming general elections, possible future study could looks how
capital markets react to the announcement of political parties’
manifestoes, looking centrally at how the proposed fiscal policy affects
the market.
This paper was undertaken with the goal of learning more about capital
markets as a whole, looking at aspects such as market efficiency and
the role it plays in the market place. By specifically looking at the
earnings share return relationship, my understanding and knowledge
base has been enriched.

27. 27
References:
Ball, R. and Brown, P. (1967) Some Preliminary Findings on the
Association between the Earnings of a Firm, Its Industry, and the
Economy. Journal of Accounting Research.5 (3), 55-77.
Ball, R. and Brown, P. (1968) An Empirical Evaluation of Accounting
Income Numbers. Journal of Accounting Research. 6 (2), 159-178.
Beaver, W.H. (1968) The Information Content of Annual Earnings
Announcements. Journal of Accounting Research. 6 (3), 67-92.
Fama, E, F. (1970). Efficient Capital Markets: A Review of Theory and
Empirical Work. The Journal of Finance. 25 (2), p383-417.
Financial Reporting Council (2009) ‘Louder Than Words’ Available:
https://frc.org.uk/Our-Work/Publications/FRC-Board/Louder-than-
words.aspx [Accessed: 9 December 2014]
King, B.J. (1966) Market and Industry Factors in the Stock Price
Behaviour. Journal of Business. 39 (1), 139-190
Nichols, D.C. and Wahlen, J.M. (2004) How Do Earnings Numbers
Relate to Stock Returns? A Review of Classic Accounting Research
with Updated Evidence. Accounting Horizons. 18 (4), 263-286.
UK. 2015. UK. [ONLINE] Available at:
http://www.ftse.com/products/indices/uk. [Last Accessed: 14 April
2015].

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