Does the Precision of News Affect Market Underreaction? Evidence from Returns Following Two Classes of Profit Warnings

Authors


  • George Bulkley is grateful to the University of New South Wales for hospitality during the academic year 2002–2003.

Abstract

We evaluate whether the market reacts rationally to profit warnings by testing for subsequent abnormal returns. Warnings fall into two classes: those that include a new earnings forecast, and those that offer only the guidance that earnings will be below current expectations. We find significant negative abnormal returns in the first three months following both types of warning. There is also evidence that underreaction is more pronounced when the disclosure is less precise. Abnormal returns are significantly more negative following disclosures that offer only qualitative guidance than when a new earnings forecast is included.

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