Ryan Ball Chicago Booth School of Business & Peter Easton

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: Indiana University September 3, 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 • generally implicitly assumed to be the same on each day • varying degrees of permanence • may change in predictable ways • from beginning to end of year • on earnings news days • when prices stray from fundamentals

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? Bad news more transitory/less permanent 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. January Effect? January Effect? Number of trading Day Relative to First Day of the Fiscal Year, t

20. January Effect

21. Figure 7Estimates of net income/daily returns coefficient Controlling for incremental changes during January:Partitioned by sign of fiscal year returns 0.158 (10.39) slope -0.009 (-0.016) 0.160 (10.02) 0.148 (9.72) slope 0.010 (0.067) 0.084 (6.79) 0.029 (2.47) 0.073 (5.35) 0.026 (2.36) Number of trading Day Relative to First Day of the Fiscal Year, t

22. Control for Change in Variance

23. Figure 8Standard 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

24. Figure 9Estimates of net income/variance-adjusted daily returns coefficient: Controlling for incremental changes during January 0.539 (11.72) 0.447 (9.57) 0.472 (10.21) 0.399 (8.24) 0.314 (6.96) 0.113 (2.32) 0.214 (4.85) 0.075 (1.67) Number of trading Day Relative to First Day of the Fiscal Year, t

25. 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 Net Income (+) 0.022 0 252 0.006 Period Expense (-) Number of trading Day Relative to First Day of the Fiscal Year, t -0.186

26. 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 • News on earnings announcement days has a more transitory effect on earnings than news on non-earnings announcement days • Prices stray from fundamentals • may affect the return/earnings relation