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The effect of meeting or missing earnings expectations on information asymmetry
Stephen Brown, Emory University
Stephen A Hillegeist, INSEAD
Kin Lo, University of British Columbia
ABSTRACT. We examine the effect of meeting or missing earnings expectations on the level of information asymmetry. We measure the latter using the probability of informed trading (PIN). We find that PIN decreases (increases) when firms meet or beat (miss) earnings expectations and that these changes increase with the magnitude of the earnings surprise. Firms that regularly meet or beat (MBE) show a stronger decline in PIN compared with those achieving MBE sporadically. Furthermore, we find that the reduction in asymmetry for MBE firms disappears when firms likely engaged in expectations management, but we find no evidence that earnings management affects the reduction in asymmetry attributable to MBE. Our evidence largely corresponds to results regarding the pricing premium associated with MBE, and suggests that up to 30-40% of the MBE pricing premium is attributable to a “denominator effect” where investors discount future cash flows at lower rates because of reduced information asymmetry.
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