Market - Wide commonalities in corporate earnings and significance tests of accounting beta

Abstract

Financial theorists have emphasized for years the importance of expectational variables in the valuation of shares. The price of share is determined primarily by investors current expectations about the firm's future performance of earnings and particularly the anticipated growth rate of earnings. During the period of earnings announcement, any change in prices is generally a reflection of how much shock or surprise they get from the recently observed earnings. Recent development in capital theory also provides justification for selecting the behaviour of security prices as an operational test of usefulness of income numbers. If information is useful in forming security prices, then the market will adjust prices to that information and then changes in prices will reflect the flow of information to that market. However, the major problem involved in determining the information content of financial report is to identify the portion of the total information that was already expected by investors prior to the information release. Since only the unexpected component of total information would be relevant to the market, the economic consequances of according earnings information cannot therefore be studied without obtaining a surrogate for the market's expectation of such earning.