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Chapter 5

BU457 Chapter Notes - Chapter 5: Abnormal Return, Event Study, Stock Split

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Bixia Xu

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Chapter 5
Accounting research has concluded that security market prices do respond to
accounting information
o First significant evidence of this was from Ball and Brown in 1968
Information is useful if it leads investors to change their beliefs and actions
o Degree of usefulness can be measured by the extent of volume or
price change following the release of the information
Information approach approach to financial reporting that recognizes
individual responsibility for predicting future firm performance and
concentrates on providing useful information for this purpose. Assumes the
market will react to useful information from any source
while investors and accountants may benefit from useful information, society
may not necessarily be better off
o There is a cost to acquiring information that some of society may not
feel it is worth the usefulness associated with the information
Efficient market theory implies that the market will react quickly to new
information. Therefore it is important to know when the new information is
released (ie. The current year net income)
Good or bad news relating to net income is evaluated relative to what
investors expected.
Market response to reported net income can be hard to find. There are other
factors in the market that affect a firms share price. Thus, it is desirable to
separate the impacts of market-wide and firm-specific factors.
Separating Market-wide and Firm-specific Factors
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The 0.0006 represents the abnormal firm-specific return on firm j shares for that
day (or the rate of return on firm j shares for day 0 after removing market wide
Researchers may want to look at a few days before and after day 0. The market
may learn of good or bad news early, and the affects may last a few days after
A complication arises when other firm-specific comes the same time as earnings
announced (ie. A stock split). Hard to know if market response was due to one or
the other.
Another complication is the changing of a firms beta over time. This affects the
estimation of the abnormal return
o There are other alternatives of estimating abnormal returns that do not
involve beta
Ball and Brown Study
Performed a type of research called event study (market reaction to specific
events of a firm and its net income)
Firstly measured whether reported earnings were greater (good news) or
less than (bad news) what the market expected. Previous years earnings
were used to compare
Next, they used the graph above to calculate a firms abnormal return
B&B used this across their sample size and concluded that this generally the
case for all firms
This study was repeated over a wide window, 11 months prior to the event
was tracked, and 6 months after the event was tracked
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