5.

2 outline of the research problem

Reasons for market respons
We begin by reviewing the reasons why the market price of a firms shares may respons to financial
statement information. For most of this chapter we will confine financial statement information to
reported net income.

Consider the following predictions about investor behaviour in response to financial statement
information :
1. Investors have prior beliefs about a firms future performance that is, its dividens, cash flow, and
earnings which affect the expected returns and risk of the firms securities. These prior beliefs will be
beased on all avaible infotmation, including market price up to just price to the release of the firms
current net income.
2. Upon release of the current periods net income periods net income, some investors will quickly
decide to become more informed by analyzing the income number.
3. Investors who have revised their belifs about future firm performance upward willbe inclined to
buy the firms shares at their current market price, and vice versa for those who have revised their
brliefs downward.
4. We world expect to observe the volume of shares traded to increase when the firm reports its net
income.

Beaver (1968), in a well known study, examined trading volume reaction. He found a dramatic
increase in volume during the week of release of earnings announcements.

finding the market response

1. Efficient market theory implies that the market will react quickly to new information. It is
important to know when the current years reported net income fire became publicly known. If the
market is going to react, it should do so in a narrow window of a few days surrounding these dates.
2. The good or bad news in reported net income is usually evaluated relative to what investors
expected. Investors prior beliefs would have already been revised to reflect the earlier information.
3.There are always many events taking place that affect a firms shares volume and price.