Abstract
We test whether the well-documented market reaction to the announcements of earnings surprises is a manifestation of an investor underreaction or overreaction to extremely good or bad earnings news. Using the market reaction in the three-day period surrounding the announcements of extreme earnings surprises (i.e., SUE) in quarter Qt as a reference point, we show that firms reporting a high (low) SUE in subsequent quarter Qt+1 that confirms their initial quarter Qt SUE ranking in the same highest or lowest SUE quintiles generate an incremental price run that moves in the same direction as that of the initial SUE. However, the price impact of the confirming SUE signal is weaker than that of its initial SUE. Our findings are robust to the Fama-French three-factor daily regression extended by the momentum factor and a number of other robustness tests. Our result is not consistent with the prevalent view that investors underreact to earnings news. To the contrary, the evidence suggests an initial investor overreaction to extreme SUE signals.
•We test whether the market reaction to the announcements of earnings surprises (SUE) is a manifestation of an investor underreaction or overreaction to extreme earnings news.•Firms reporting an extreme SUE in subsequent quarter that confirms their initial SUE ranking in the highest or lowest SUE quintiles have an incremental price run that moves in the same direction as that of the initial SUE.•We find that the price impact of the confirming SUE signal is weaker than that of its initial SUE.•Our findings are robust to the Fama-French three-factor daily regression extended by the momentum factor and a number of other robustness tests.•Inconsistent with the prevalent view that investors underreact to earnings news, our results suggest an initial investor overreaction to extreme SUE signals.