Firms’ Information Environment: Implications for Investors’ and Managers’ Decisions

HANN, Rebecca N. | KIM, Heedong | 鄭悅

An earnings announcement – a public statement of a company’s profitability, usually issued on a quarterly basis – provides useful information to assess peer firms’ expected cash flows, as well as the uncertainty regarding their expected cash flows. While there is a large body of research on whether there are intra-industry information transfers around earnings announcements – much of which focuses on the transfer of first-moment information that can lead to a revision in the market’s expectation about peer firms’ stock returns – little is known as to whether there are transfers of second-moment information that lead to market revision of expectations regarding peer firms’ return volatility.

A recent paper by Rebecca Hann, Heedong Kim, Yue Zheng looked to fill this knowledge gap by “examining whether there are second-moment intra-industry information transfers around earnings announcements that can help resolve uncertainty about peer firms’ fundamentals, and if so, how the nature of the information conveyed in earnings announcements affects this information transfer”. Using implied volatility from exchange-traded option prices as a proxy for uncertainty about firm fundamentals, the study uses a sample of 24,232 firm-quarter observations, comprising 3,030 unique firms operating in 217 industries at the four-digit Standard Industrial Classification level from 1997 to 2017.

To answer the question, the authors first identified a set of ‘first announcers’ or ‘initial’ announcements – the first firm to release earnings in each industry quarter – and matched these firms to industry peers who announced their earnings at least ten trading days after the first announcer. They then examined the association between the changes in implied volatility for the first announcer and its peers around the initial earnings release. The results revealed that, around the first announcer’s earnings announcement, its changes in implied volatility were significantly positively associated with those of its industry peers, consistent with the presence of second-moment information transfer.

Further, the magnitude of information transfer was discovered to be stronger for long-duration options, when the announcer had higher earnings quality, reported positive earnings news, or was a bellwether firm, as well as during periods of greater macroeconomic uncertainty. As the authors themselves point out, the weaker result for short-duration options is unsurprising, since short-term options tend to reflect primarily firm-specific information which is more transitory in nature and less informative about peers, and the stronger result for long-duration options suggests that information about industry and market uncertainty tends to be more persistent. The findings point towards earnings announcements conveying information that helps resolve uncertainty about the value of not only the announcing firm, but also its industry peers. The research also supports the notion that the extent of information transfer varies predictably with the nature of the news and the quality of the earnings signal, meaning that the transfer of volatility-relevant information stems from the announcer’s earnings news. Hann, Kim, and Zheng determined that these results remain consistent after controlling for information transfer in respect to the first moment of returns.

Finally, the study looked at the implications of second-movement information transfer on volatility risk around earnings announcements. The authors show that there is a substantially positive association between the volatility risk premium of the first announcer and that of its industry peers, suggesting that “investors anticipate heightened volatility risk at the announcer’s earnings announcement to spill over to its industry peers and pay a premium to hedge this risk”. This spillover is more obvious when the announcing firm’s volatility co-moves more strongly with the market. Ultimately, what this means is that while earnings announcements do indeed convey useful information about industry uncertainty, anticipation of said information poses non-diversifiable volatility risk to industry peers.