We study the relative usefulness of earnings announcements for valuation from the perspective of information externalities: the use of industry peer information for valuation, particularly for IPO pricing. Externalities of accounting information are one of the primary justifications for disclosure regulations. Assessment of the usefulness of earnings announcements is therefore incomplete without understanding how such information is used for peer equity valuation.
It is not obvious that earnings announcements or other information should matter more for peer share valuation. Prior research suggests that accounting information is by nature low frequency, not discretionary, and primarily backward-looking. Other information, in contrast, is higher-frequency, usually discretionary, and both forward- and backward-looking. Earnings announcements thus may provide less useful information for stock valuation than other news events. However, accounting information is also independently audited and produced based on independently observable outcomes, while non-accounting information tends to be softer and less verifiable, potentially incorporating significant biases. This suggests that earnings announcements are more reliable and useful than other news events. In addition, while research shows that earnings announcements contain information about industry-wide trends, other peer information can be related to firm-specific events, such as changes in management and strategies or mergers and acquisitions. Such idiosyncratic news matters for the valuation of the announcing firms but it is likely to be less informative about industry-wide changes and therefore is less relevant for the valuation of industry peers.
Following prior research, we use returns around (outside) earnings announcements to capture earnings announcement (other) information. We assess the usefulness of earnings announcement and other information to IPO pricing by estimating the impact of earnings announcement information and other information on IPO offer-price revision over the IPO filing period, which is the period from IPO filing date to IPO issue date. The setting of IPO price revisions offers at least two advantages for comparing the relative usefulness of peer information from different sources. First, there is limited information transfer from IPOs to industry peers, due to both the absence of stock trading before IPOs and the SEC’s strict quiet-period restrictions. As a result, the direction of information transfer (from industry peers to IPO firms) is less ambiguous. In contrast, in other settings where all firms are publicly traded, stock prices can reflect both corporate disclosures and information impounded through investor trading, which makes it difficult to establish the direction of information flow. Second, the importance of peer information decreases with the amount of firm information available to investors. The valuation of IPOs provides a powerful setting for studying the spillover effect of peer information, as there is limited information about firms seeking to go public, and signals from peers can be particularly useful. We expect peer information released during the filing period, both earnings announcements and other news, to be an important determinant of IPO price revisions.
Our empirical analyses, based a sample of 5,783 U.S. IPOs from 1983 and 2017, indicate that the per-unit usefulness of peer earnings announcements is higher than other news in IPO pricing. Specifically, we find that a 1 percent change in peer valuation caused by earnings announcements results in approximately 60 percent larger IPO price revisions than does a 1 percent change in peer valuation caused by other information. High accounting comparability and reporting quality of peer firms further improve the per-unit usefulness of peer earnings announcements, consistent with the reliability of accounting information being an important driver of the relative usefulness of earnings announcements over other news. We also provide evidence rejecting an alternative explanation of reverse information flow from IPO firms to industry peers.
Additional analyses indicate that IPO issuers avoid setting their offering dates to immediately precede peer earnings announcements, suggesting that peer earnings announcements provide important information that helps resolve significant information uncertainty, and IPO issuers prefer to schedule IPOs after the resolution of such uncertainty.
Last, we find that earning announcement information positively predicts IPO first-day returns, which indicates that IPO offer price adjustment is incomplete with regard to earnings announcement information; in contrast, we find no evidence of partial adjustment of IPO offer price in response to other information. Thus, the partial adjustment phenomenon in IPO pricing does not explain our finding that peer accounting information is more useful than other peer information. In fact, the partial adjustment of IPO offer price to peer accounting news suggests that our price-revision-based estimate understates the incremental usefulness of peer accounting information over other peer information.
Overall, we provide new evidence on the relative importance of earnings announcements for peer equity valuation. Complementing recent research that focuses on the amount of earnings versus other information for the valuation of a firm, we evaluate the externalities of earnings announcements on a per-unit basis. Our findings indicate that, in IPO pricing, same-industry peer earnings announcements have a significantly greater effect than does other peer news on a per-unit basis, thus furthering the understanding of the relative usefulness of accounting information for valuation.
This post comes to us from professors Ivy Zhang at the University of California at Riverside and Yong Zhang at Hong Kong Polytechnic University and PhD candidate Xiaoxu Ling at Hong Kong Polytechnic University. It is based on their recent article, “Usefulness of earnings announcements and other news:Evidence from the impact of peer information on IPO price revision,” available here.