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Electronic copy available at: http://ssrn.

com/abstract=2128616
The Information Value of the Annual Earnings Report
by
Ray Ball and Philip Brown


First Draft
October 1967


Abstract

This working paper is the first draft of our co-authored publication, "An Empirical Evaluation of
Accounting Income Numbers," Journal of Accounting Research 6, 1968, pp.159-78. While undated,
it subsequently was presented at the November 1967 Seminar on the Analysis of Security Prices
organized by the Center for Research in Security Prices (CRSP) at the University of Chicago. It was
included in the November 1967 Proceedings of the Seminar on the Analysis of Security Prices.

In 1986, the published version received American Accounting Association’s inaugural award for
Seminal Contributions to the Accounting Literature. Interest in the historical development of the
paper was rekindled by the American Accounting Association appointing the authors as its 2012 co-
Presidential Scholars and organizing a Plenary Session entitled “Ball & Brown [1968]: A Seed That
Made a Difference” at its 2012 Annual Meeting in Washington, D.C.


Electronic copy available at: http://ssrn.com/abstract=2128616
First Draft
Comments Welcome
"*"*
THE INFORMATION VALUE OF THE ANNUAL EARNINGS REPORT
 
"* Ray Ball, and Philip Brown
"*"*
The authors are indebted to OWen Hewett and Ian
watts for assistance in computer programming.
"* University 01' Chicago
;.
10 INTRODUCTION
The information value of the annual earnings report
l
is a subject of con-
cern to accountants and to users of accounting data alike. Our aim in this
paper is to assess the information value of earnings reports empirically, This
will involve an evaluation of the timing as well as the contents of earnings
reports, for information could be lacking as a.res.ult of defiCiencies in either,
The paper will be an attempt to d.escribe what is} and will have nothing to say
about what might otherwise be.
A first step is to provide a model which links annual earnings numbers
to stock prices. Unfortunately, in theory} no such link exists, While it has
Irving
been accepted since/Fisher that assets would be priced) under ideal conditions
(including perfect certainty)} at the present values of their future earnings
streams, the removal of these ideal conditions creates two major problems. The
first is the need to understand. the marketUs preferences for alternative, un-
certain returns conditional upon the various possible outcome states of the
world, and the second is the need to determine how the market uses observed
(accounting)earnings to estimate these future returns, Perhaps the closest we
have come to a formal theory relating the two is due to Miller and Modigliani
(1966), Yet their work does not provide a complete theory of valuation under
conditions of uncertainty, The relation between earnings and prices in the
Miller-Modigliani system is a matter of definition rather than   it
is a tautology in design and intent,
  wish to emphasize that, throughout this paper, we shall be using the
term flearnings report" to refer to the reporting of that number designated as
fldollars of net income," or some transformation of that number, for example
earnings per share (EPS)o Specifically, we shall not be assessing the information
value of any items other than net income, even though they may be reported in
the Income Statemento
-2-
Our approach to relating accounting information to stock prices will
avoid attempting to explain prices in terms of given variables. Instead, we
shall focus on changes in expectations which are occasioned by releasing the
earnings report. The presumption is made that observed earnings are related
to expected returns, which are inputs to the asset pricing decision. We pro-
pose no further hypotheses about the nature of the pricing decision, nor about
the manner in which expectations are formed. The specific technique will be to
construct two alternative models of what the market "expects" earnings to be,
and to investigate its reaction when these expectations prove false. The next
section is devoted to describing the two models. The remainder of the paper
deals with the mechanics of testing, the results obtained, and the implications
of the results.
II • THE MODElS
The first (naive) prediction model is that the world will remain un-
changed: that earnings will be the same for this year as for last. Its fore-
cast error is the change in earnings since the previous year.
The second model focuses on that which is unique about the firm, as
opposed to that which is common to all. For example, since most firms earned
higher EPS in 1965 than in 1964, one would be interested not so much in the
fact that a particular firm was able to increase its EPa, but if it wer:e able to
sustain or improve its position relative to others. In order to determine a
firm's relative position in a given year, we first estimate, by Ordinary Least
Squares, the coefficients from the linear regression of the change in the firm's
earnings on the change in the average earnings of all firms in the market, using
-3-
data up to the end of the previous year.l Expected earnings for the second
model, called the regression model, is then given by the regression prediction
using this year's change in the average earnings for the market. The forecast
error is actual earnings change minus expected.
Our objective in defining a forecast error is to determine if the in-
formation contained in the annual earnings number for a particular firm may be
termed "good
l1
or l1bad" news. If the forecast error is negative (Le., if
actual is less than expected), we define it as "bad" news, and conjecture that
it would result in the return on that firm's securities being less than the
return which would have been expected if all one knew were (a) the past associ-
ation between the returns on these securities and on the market, and (b) the
present market index. The converse should hold for a positive forecast error.
The return which would have been expected may be estimated by its pre·-
dicted value from the linear regression of the natural logarithmic transforms
of the price relatives
2
of the firm's securities on the market index.
3
The
residual from this regression measures the extent to which the realized return
differs from the expected return conditional upon the estimated regression
parameters and the market index.
lEarnings regressions estimates reported in this paper are all based on
Ordinary Least Squares applied to the variables measured in their first differ-
ences. An extended discussion of the econometric problems encountered in estima-
ting the degree of the association between the earnings of the firm and the
market is contained in Brown and Ball (1967).
2The stock price relative for security j in period t (PR
jt
) is defined
(d_
t
) + closing price (p. t+l)
J J,
divided beginning price (p . t) :
J u
as dividends
PR
jt
= (Pj,t+l + djt)/Pjt
3The stock return model has been discussed at length elsewhere [e.g., Blume
(1967), Fama, et alia (1967)]. The lihk relative of Fisher's "Combination Invest-
ment Performance Index" (Fisher, 1966) is used to estimate the market effect.
-4-
The structure to be used may be summarized as follows:
a. determine the !lunexpec earnings change, or forecast error, and
classify the firms in the sample according to whether the information contained
in the annual earnings number is "good" or "bad" news (that is, according to
whether the sign of the forecast error is positive or negative); and
b. take each of these two separate classes of firms and examine the
behaviors of the !labnormal!! returns for the average firm in each class--that is,
the regression residuals from the log-relative regressions--to measure the in-
formation value of the annual earnings report.
Two basic models have been defined, a regression and a naive model. We
shall report on two measures of earnings (Net Income, and EPS) for the regres-
sion model, and one measure (EPS) for the naive model. In subsequent dis-
cussion they will be identified as variables (1), (2) and (3) respectively.
III. DA'I'A
Three classes of data are of interest: the contents of earnings reports,
the dates of the reports, and the behaviors of security prices in relation to
these reports.
Earnings numbers for 1946 to 1966 were obtained from Standard and Poor's
compustat tapes. The distributions of the squared, product-moment coefficients
of correlation between the changes in the earnings of the individual firms and
changes in the market's earnings are summarized in Table 1.
lThe market net income series was computed as the sample mean. The mar-
ket EPS series was computed as a weighted average over the sample members, the
number of stocks outstanding (adjusted for stock splits and stock dividends)
providing the weights. Note that, when estimat the association between the
earnings of a particular firm and the market, the earnings of that firm were
not used in computing the market index.
-5'-
Table 1: Deciles of the Di.stribution of Squared, Product-Moment Coefficients of
Correlation, Firm and Index*
Decile
.1 .2
·3
.4
·5
.6
·7
.8
·9
Variable (1) .03 .07 .10 .15 .23
·30 ·35
.43 ·52
Variable (2) .02 .05 .11 .16 .23 .28
·35
.42
·52
*Estimated over the 21 years 1946-1966.
Annual report announcement dates. The Wall Street Journal publishes
three kinds of annual report announcements: forecasts, as made, for example, by
the corporations' presidents early in January; preliminary reports, and the
complete annual reports. Forecasts are often imprecise, to be contrasted with
the preliminary report, which is typically a condensed previevJ of the annual
report. Because the preliminary report usually contains the same numbers for
net income and EPS as are later given with the fi.nal report, the announcement
date (or effectively, the date on which the annual report became generally avail-
able), was assumed to be the date on which the preliminary earnings report was
announced in The Wall street Journal. If there was no preliminary report
announced in the Journal, the date of the complete annual report was used.
Table 2 reveals a developing tendency to release the report more
stock price relatives were obtained from the Center for Research in
Security Prices (CRSP) tapes, which contain data from January, 1926 to June, 1966.
The data used are monthly closing prices on the New York Stock Exchange, ad-
justed for dividends and capital changes. The natural logarithms of the monthly
price relatives are thus monthly returns, compounded continuously.
Inclusion Criteria. To be included in the study, a firm had to meet
the following requirements:
1. earnings data available on the Compustat tapes for each of the years
1946-1966 ;
*
  2 'l'ime Distribution of Announcement Dates
% of Pinus   -- Fiscal Year
......-
------
1221
1960 1962 1964
;L965
25 2/07 2/04 2/04 2/03 2/02 2/0:'5 2/03 2/01 1/31
50 2/25 2/20 2/18 2/17 2/15 2/ 2/13 2/09 2/08
75
3/10 3/06 3/05
3/0lj. 2/28 2/"") '- ....
-x-
Inso:f:'fl.r as the reporting delay is not reported in day,,) a
slightly d:Lstorted is g1ven, 'l'he first 1n the column headed
"1957 II indicated that 25'%, of the earnings s for the fiscal year ended
12/13/1957 had been announced
2, fiscal year Decerriber 31;
3, price data available on the CRSP tapes for at least 100 months; and
lj., Wall Street Journal announcement dates available,
The above criteria limit our analysis to the nine fiscal
years 1957-1965, When 'tIe the study" announcement dates I{ere tale;,en from
the Journal wh:i.ch was available from 1958 on, luan
effort to minimize errors,each a,nnouncement date has
been checked against the Journal, It would be possible to go back beyond the
1957 annual report J but vie have not attempted to do so, The upper limit
fiscal year 1965, the results of which are announced :in is
the fact that the CRSP f"ile te:cm:inates in June J 1966,
'rhe net effect of the selection criteria may be to red.uce the
of the results,   sample does not include young firms) those which do not
report on December 31, and those which are not
on .:";:':;::£..:::: .. ::':':':"J
th,e
CRSP and the Wall Street and as a result it may not be repre·
..
sentative of all fJ.rms, our conclusions vlDUld be different 1:f a more
widely based sample 'Here used) but data collection :p:roblems prohibit such an ana1y-
sis, In any event, the results
the 287 fi:rmsl which met our selection cri.teria
are probably significant in their aIm right,
IV, RESULTS
Overview
-
Figures 1 and 2 and 'fable 3 reveal a marked assoc:Latlon between
the signs of errors in forecasting earnings and the signs of the monthly :rates
of return residuals, The Chi-sCluare Gtatistic) shown in Table .3, also shows it
to be most unlikely that there is no relationship bebleen the direction of the
forecast earnings error and the direction of the rate of return residual in most
of the months up to the announcement of the annual The results :in
Table .3 have been averaged over all firms and all years J wh:Lle 'rables 4 and 5
g:Lve separate results for each of the last three years,
The drifts up,\·,rard and downward in the cumulat:Lve average return residuals
begin at least eleven months before the report is released and continue for approx""
imately one month after, The of the drifts is indicated by the con,·
stant signs of the cumulative in Table 3 J and by their almost monotonic
increase, This suggests that the market begins to anticipate Wlforecast errors"
early in the twelve months preceding the report, and continues to do so with
increasing success throughout the year, In fact) anticipati.on is so accurate
actual earnings 1;;:.1,,·\';1'
that the/number does not appear to cause any unusual movements in the cumulative
residuals during the month of its release . 'rhe apparent signi;f'icance of the
classification of firms by sign of forecast error is ev1dence that the marl"et does
take heed of earnings nl1.mbers, or at least of the same sort of information as
is reflected in them.
-"-,------------"""....-...,.--____ ______ _________ ><=>,=_== ......     _______ __________ __________
1
Due to data deficiencies, not all 287 firms are included in all 9
years. The effects are most noticeable in 190f and 1965, -when 19 firms were
excluded.
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-10-
Table 3: Sumraary Statistics by Variable and. Month He1ati ve to Annual Report
Announcement Date-"·JU1 Years
Month Relative to
Variable (1)1 Variable
)1
Variable
Annual Heport
Announcement Date
-11
-10
-9
-8
_7
,
-6
t:;
-:;
-3
-2
-1
0
+1
+2
+3
+6
1
Key:
(1 )
-,008
-,016
- ,021
- ,026
=,038
-  
-,058
-,067
- ,073
=,076
-,082
-,088
- ,093
- ,090
- ,093
., ,093
- ,09)+
- ,097
(2 )
+,0°7 23·0
+ ,1
+,017 6,3
+,021 9,7
+,026 33,7
+.033 ,9
+.038 18,7
+ 34,1
+ ,057· 31,1
+,057
l+,J+
+,060 7,1
+, 23,8
+,072 3,9
+,074 1,7
+,075
2,1
+,075
0,1
+ ,072 0,8
+,071 0,9
Variable Defi.ni tions
(2 )
-,008 +,008
=,017 +,
= ,021 +,017
+,022
+ ,028
- ,0:30 + ,032j.
+,039
- ,068 +,
-,075 +,059
+,059
- ,08)+ +,063
- ,090 +,073
- ,094 +,074
- ,090 +,074
-,091 +,
"" ,093 +,
- ,094 +,074
- ,097 +,072
Variable (1) Regression Model--lIJet Income,
(2) Regressi.on Mode1--EPS,
(3) lIJaive Model--EPS,
Column
. (3)
23·0
=,011
21,2
4,2
9,9 -,039
34,6 -,050
29,7 =,060
,7 - ,072
38,4 - ,082l-
31)1. - ,093
1+.6
- ,092
8,2
-.099
29,1 -,107
2,7 -,111
L3
=,111
0,6 -,112
0,0
0,1 - ,.110
1 0
,/ -,112
(1) Average Cumulative Stock Return Resi.duals-
}<1orecast Error < 0,
(2) Average Cumulati.ve Stock Return Resi.duals-
Forecast Error> 0,
+,007
+,015
+,Or(
+ ,021
+,023
+,026
+,031
+,°39
+,
+,
+,
+,056
4-' 0
+,065
T,
+,
+,060
+,058
)1
)
29,9
69,6
,0
7,1
18,8
,2
28,4
31,8
 
0,1
6,2
29,5
7,8
709
0,0
o 0
,C/
0,5
0,6
-11--
Table 3 (continued)
Note
(3) Chi-Square Statistic for     Classification
Sign of Earnings Forecast Error (for the year)
and Sign of Stock Return Residual (for the Indi.cated
Month) •
p (Chi-Square 3.81l-
x2
0) =: for 1 degree of freedom.
p(Chi-Square > 6.64
2
X ::: 0) ::" .01; for 1 degree of freedom.
·-12-
Table Average Cwnulative Stock Return Residuals .. Forecast Error
Negative--1963, 1964 and
Month RelatJ.ve to
1
1963 1964
1
1965
1
Annual Heport
Announcement Date Var(l) Var(2) Var Var Var ) Var(3) Var Vax' Var )
-11 -,004 -.006 -.016 +0 +, +,012 .. ,019 .. ,020
-10 -,007 -.007 .020 ,000 +. - 0025 - ,029 - ,
-9
-,016 -,015 - -.012
-
- ,04,0
-8 - .020 -,019 ..   ", .020 - ,014·
..
-.042 -,oh6
_7
-.034 - •
..
- .029 - -.051 - ,U'Y:;! -,
I
-6 -.046 ..• 045 =,.078 -0042 =.039 ... 097 -.067
= = .112
-5
,- ,01.((
- .0!+7
.088
-
-4 ,038 -,081 .. ,052 - ,120 -.091 - ,
,- 3 - ,OLj.2 -.044 - .062
.. ,1)-1-6
- -.117
-2 - .042 -.043 =.092
.,
- .062 .. ,130
- """ oeL
-1 - ,0i+7 - 0011-9 -.100 - ,062 -,138 -,119 -
0 - .o!+o -.043 -.099 - -.143 -, .1.36 -.147
+1 - .028 -,031
- - 0165 =.149
+2 -.019 .. ,020 ..• 067
.' -,175 - - ,179
+3
... 029 - .032
' 2
+It - .03)j.
-.037 - - .182
+5 -,036 .- 0011-0
- -,176
I'
J:"-1,
+6 -.040 - - ,093 - - .17
1
+
N 155 15.5
10'5 101
key to Table 3 for variable definitions,
2N/ A: Not available (the CRSP file terminates in June, 1966),
Table Average Ctunulative Stock Return Residua1s- Forecast Error
Positive--1963) 1961j, and 1965
1
19611.1
1965
1
Month Relative to
1963-'-
Annual Report
Announcement Date Var(l) Var(2) Val'
-11 +.009 +,011 +.009 +, + .01,3 -.001 .000 -.004

+.037 +.037 +. +.031 +.027 +. +.01] +,016
,
T,
--9 +0050 +,048 +,032 +, +,028 + .023 +,016 +,018 +.008
-8 + .Oi+7 +,046 +, +,038 + + .025 +.013 +.017 +,
-7
+,050 +, + ,029 +,044 +.039 +,027 +,010 +, +,001
-6 +.076 +.075 + +.041 +,037 + ,024 + ,021 +.026 +,
+ ,08LI- + ,08Lt + +,033 +, +.021 +.030 +, +,
-4 +,096 +.096 +.063 +, +,038 + .021 + + ,0511- +,
+ .105 +,107 + + +0 +,020 +   +,
+'Il
-2 + ,111 +,11] +, +,026 +,025 +,011 +,O':H +,
-1 + ,121+ + .127 +,081 ,0]1 + ,029 +,015 + +,Ob2 +0
0 +,144 + + ,098 +,041 +,0]8 +,023 +.060 +,071 +,
+1 + ,163 +,165 +. +,039 + .023 +,054 +,Obb +,
+2 +,164 +.165 +, +. +. + +. +, +,
+3 +,167 +,170 +, +,Oh2 +. + ,023
+4 + ,174 +,178 +,117 +, +,024 +.019
+,173 +,178 + .+ .030 + ,022 +,
N/A
+6 +,169 +,174 +,112 + .026 +. + .Oll} N/A N/A
N 128 128 161 167 233 156 154 222
lSee key to 3 for vari.able defi.nitions"
-14-
Specific Results
L While there may be some suggestion in Table 3 that, at least for
variable (3), the relationship between the sign of the forecast earnings error
and that of the stock return residual may exist for as long as two months
beyond the month of the announcement of the annual report, Table 3 also sholtfS
that, unless transactions costs are within about one-half of one per cent,
there is no opportunity for excess profits once the earnings information has
become generally available. This result is consistent with other, similar
evidence in support of the random walk hypothesis.
1
It should be noted that Figures 1 and 2 are averages over all firms and
years, and are not necessarily indicative of the behavior of anyone firm in any
one year. Although there may be, on average, a persistent and gradual anticipa-
tion of the report throughout the year, other evidence on the amount of auto-
correlation in the stock return disturbances [for example, Fama, et alia (1967)J
suggests that the only opportunity for excess profits would come from superior
ability to predict the direction of forecast errors in advance of the market.
The extent of the potential gains from a superior ability to predict
forecast errors can be seen from the cumulative average stock return residuals
reported in Table 3. Ignoring transactions costs, the ability to exactly pre-
dict, one year in advance, which of the stocks in the sample will report an in-
crease in EPS would leave one about 5-6% p.a. better off [variable (3), column
(2), month OJ than one might otherwise have expected. Had one purchased the
stocks with decreases in EPS, the relative loss would have been 10% p.a.
[column (l)J.
1
For example, Scholes (1967).
-15-
2. Tables 4 and 5 illustrate that, although the pattern over nine years
is as shown in Table 3, it makes a difference which year one investigates. The
earlier months of 1964 indicate some misclassifications of firms by all models.
These "untidy" classifications average out when pooled over all years, as shown
by the uniqueness of the signs in the columns of Table 3. Similarly, 1963 and
1964 reveal some perverse results in the month of the report announcement, and
this also disappears on pooling with other years. The differences between years
represent sampling fluctuations, hence our emphasis on the average results.
3. Figure 3 depicts the average absolute magnitudes of the return
residuals for months relative to   If there is any period in
which activity is greatest, it appears to be the six months beginning four months
before the report date. Figure 4 is designed to reveal some of the properties
of our sample. For the most part, the average cumulative residual is negative.
Since the return residuals are constructed by regressing monthly returns on the
market index, their expected value should be zero, The fact that they are not
identically zero is evidence of a small bias in our sample, for which we have
not attempted to correct.
4. The naive model performs better than the regression model for firms
with negative earnings forecast errors. The explanation is simple. The naive
model gives the same forecast error as the regression model would give if
(a) the change in market earnings were zero, and (b) there were no drift in the
earnings of the firm. But historically there has been an increase in the market's
INote that the broken vertical axis visually distorts the magnitudes.
Note also that the plots for months -11 and +1 are not identical, because
(i) the report announcement dates may be different each year and (ii) the particu-
lar years from which the average observation is computed are not the same for,
say, -10 and +2, due to these months taking us into 1957 and 1966 at the two
extremes.
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I

-18-
earnings during the sample period, due to price effects, the strong in-
fluence of the protracted expansion since 1961, and (possibly) a sample selection
bias. Thus the naive mod,el typically identifies as firms with negative forecast
errors those relatively few firms which have shown decreases in earnings when the
earnings of most firms have increased.
This "imbalance" in the number of negative versus positive earnings fore-
cast errors under the naive model can be seen from the last rows in Tables 4 and
5, which give the numbers of firms with negative and positive earnings forecast
errors for 1963, 1964 and 1965. The proportions of firms with negative forecast
errors under variable (3), the naive model, is relatively much less than for
either variables (1) and (2).dI Of the three variables, one would be most con-
fident that those which show negative earnings forecast errors for variable (3)
have lost ground relative to the market. In addition, the fact that the results
for negative forecast errors are stronger for variable (3) than for either of
variables (1) and (2) points to a relationship between the magnitudes of the
earnings forecast errors and the stock return disturbances. This conclusion is
reinforced by Figure 2, which shows that the results for positive forecast errors
are weaker for variable (3) than for the other two.
5. We have so far reported results for the regression model using EPS
and net income as earnings variables. There are many conventional ways in which
income is defined, and these are just two. We also have computed the results
for the following alternative definitions of  
(i) cash flow, as approximated by operating income; and
lDuring the over-all sample period) the earnings forecast error for vari-
able (3) was negative on 945 occasions out of a total of 2511. The correspond1ng
numbers for variables (l) and (2) were 1198 and 1203.
net income with nonrecurring items (such as special costs or
profits) added in,
'rhese variables did not prove to be as successful in predicting the sign of the
stock return residuals as the ones v.ihich we reported,
l
Value of Annual Information
The total value of new monthly information available to the mar}cet con-
an individual firm can be measured as the swn of the average absolute
stock return disturbances, This sum is a measure of 1nformation as perceived
by the market--it shows the total ad.justments to the firm mad.e over the months)
after removing market-wide ustments 0 For our over all firms
and years j mis came to 0, which is the swn of the twelve monthly observations
from .. 11 to 0 in Figure 3, The net value of all of th1s information can also
be measured) as the average (over all firms and years) of the absolute values of
the cwnulative stock return disturbances evaluated at month 0, This sum was
0,164} the sum of the l"igure 3 observations) but this time with regard to
earnings
Finally j the value of information contained in the annual/numbet :Ls approximated
by the average of the absolute values of the cumulative disturbances averaged
over all firms classified by the sign of forecast error) as revealed by the
annual report, The nwnber was 0,079 :for variable )) 0 ,081 for vari.able ) and
0,075 for variable (3), From these munbers) we can conclude:
lo about 70%   55'7 -.,.164)/.557] of the value of all information
appears to be offsetting, which in turns that about 3010
lThe differences) however J are quite small. For
the average cwnulative stock return residuals; for
which were negative) were -0. 090 '(net income) including
and -0,083 (operat1ng income), numbers compare tilth
come [variable ) ,1 3]" 'l"he numbers for firms
forecast errors were +0.070, +0.072 and +0,072,
s;
month 0
erro;r's
items)
for net in'"
1;1i th -positive
-20-
2, of the which sts y less than one-half [48%, and
-calculated as .079/.164, .081/. and .075/ .161t--for varla"bles )- )]
can be associated wi th the information contained in the annual earnings repoI't;
and
3, of the total value of information contained in the annual Teport,
Table 3 ShOv1S that only approxJ.mately one-tenth (2f/o) 8% and 9%) has not been
anticipated by the month of the report. Furthermore) FJ.gure 3 and Table 3
J.ndicate that the value of the ini'ormat:i"on contained in the annual earnIngs
11,umber represents) on average) no more than about 15-20% (18%) and of
the total value of all information coming to the market in that month,
At first ) the last conclusion seems to place a 1m" value on the
information in the annual number. But sInce \"e are usJ.ng data,
and many other bits of information are usually released in the same month
example, vJ.a dIvidend announcements}, and since much of the annual income
was predictable earlier and ) the of the annual report is already one
and one-half months into history, this is not surpri at all.
Brown and Niederhoffer (1967) found that the adjustment in the
ability of interim reports to (mechanically) predict annual earnings comes ,dth
the final quarter's report 0 Together with the interpretation ven a"bove, this
could mean that the fourth report contains numerous book adjustments
which the market either foresees or chooses to ignore.
We have been somewhat ambitious in
of the relative importance of the annual
accuracy of the technlque. In fact) the
against find:Lngs in favor of the clue to
a. the as that s t o   l ~ are
from transact:ions which have taken place s
the above ions
1n view of the order of
is biased.
that are
at the end of the month'
-21-
b. the assumption that there are no errors.;
c. the discrete nature of stock price q,uotations;
d. the presumed validity of the Vferrors in forecast" models; and
e. the regression estimates of the earnings forecast errors
random variables J which implies that some misclassifi,cations of the "
earnings forecast errors are l.nevitable.
On the other hand, since the conclusions which we have drawn are con-
cerned vlith relative amounts of information} we feel that some ambition is
warranted.
v • CONCLUDING BEMl\RKS
Our treatment of the study has not been sufficiently detailed to per-
mi t all possible implications to be drawn. In we would ltke to
have used daily prtces as well.
l
Daily would have permitted, us to
identify the dates of interim reports and to gauge their effects. Other
traceable sources of information) such as divid.end and stock sp.1it announce-
ments) could have been treated likewise, rrhis would not only have to
evaluate the information conveyed by these sources J but i¥Ould have more closely
isolated that of the annual report. The of daily l¥Oulcl
also have offered a more strl.ngent test of the strong form of the random walk
hypothesl.s, Monthly data do not deny the existence of eXCess returns vd thin
the weeks) days or transactions immediately
2
annual report,
the announcement of the
l'rhe only daily data available at the time the study 'VIas conducted
were for the years 1962-1966: a short as well as possibly atypical
20n the other hand, monthly data do provide some evidence on the proba-
bl.lity of there bel.ng excess returns during perl.ods of less than one month. If,
after the period of excess returns, the expected values of the stock return
disturbances are zero, then the average of the disturbance terms for the month
followl.ng that of the report announcement reflects, asl.de from sampling fluctu-
ations, the behaviors of the fl.rms' securl.ties during the period of excess
returns.
-22-
Nevertheless) the results from monthly price data support some definite
conclusions, Although the release of a fi.rm j s annual earnings number does not
appear to convey a large amount of new information to the stoel<;:, market J the
success of even the most naive forecasting model in predicting the way in \'lhich
a stock moves relatl.ve to the market ind.icates that the market values the con-
tents of the report, The reason for the paradoxical nature of these conclusions
is both sImple and pleasing--the market Is able to evaluate other) more tImely
sources of information i.n such a manner as to antIcipate most of' the informatIon
of the annual report,
-23-
Blume) Marshall (1967), liThe Assessment of Portfolio Performance" (unpublished
PIloD, dissertation; University of Chi.cago J 1967 L
Brown; Philip and Ball, Ray (1967), nSome Prelimi.nary Findings on the Associa-
tion betw-een the Earnings of a Firm) Its Industry and the Economy , "
Empirical Research in Selected Studies Supplement
to Volume V of the Journal of ------------u ____, forthcoming"
Brown, Philip and Niederhoffer; Victor (1967), Predictive Content of
Quarterly
October} 1967),
t1 (unpublished J Uni versHy of Chicago J
Fama} Eugene, Fisher, Lawrenee) Jensen, Michael C, and Roll; Riehard (1967)"
IIrrhe Adjustment of S-tock Prices to New Informat.i.ony II Report No, 6715
(Uni versi ty of Ch:Leago: Center for Mathem_ati.eal Studies in  
and Economics J January J 19(7)) forthcoming :Ln the Internat:Lona1
Rev:Lew,
Lawrence (1966), nSome Ne\-l Stock   Indexes, H Journal ai' Bus:Lness;)
XXXIX (Supplement, January., 1966),
MHler) Merton and Mod:Lgl:Lani, Franco (1966), "Some Estimates of the Cost of
CapHal to the Electr:Lc UtilHy Industry J 1954-57)" American ___________ ._
Review) LVI J 1966), 333- 39L
Scholes} Myron J 0 (196,"(), Effect of' Secondary D:istr:Lbutions on Price H
(Unpublished paper presented at the Seminar on the .Analysis of
Pri.ces) UnJ.versJ. ty of Chicago} November 9-10) 1967),