Stock Price Reactions to Earnings Announcements in Indian Stock Market

Executive Summary The efficient market hypothesis (EMH) concept has been debated since 1950’s by academicians and professionals and even today it is an important part of modern finance. The capital market efficiency is classified into allocative efficiency, operational efficiency and informational efficiency. The EMH deals with informational efficiency which states that participants cannot outperform the market with new informational flow. Many researchers investigated the stock market reaction to informational disclosure by considering various corporate announcements such as stock split, mergers and acquisition, dividend announcement etc. Stock price response to earnings announcements has received considerable attention as earnings are considered as the firms’ performance indicator. The investors’ expectation on the extent of excess return that they would make from trading in the stock market is based on several factors and one of them is quarterly earnings announcement news. In this study, we focus on examining the stock price reactions to earnings announcements in Indian stock market using a sample of firms listed on the BSE (Bombay Stock Exchange Limited). We use event study methodology to examine the significant relationship between stock returns and quarterly earnings announcement. The BSE-500 based companies are selected as sample companies as they diversified and well traded stocks. The whole sample is subdivided in to good sample portfolio, bad sample portfolio and full sample portfolio based on percentage change in the net profit and net sales of current and corresponding quarters. We use t test (Brown & Warner, 1985) for statistical significance and Runs and Sign test for testing the hypotheses. Cohen et al. (1983 a) methodology is also used to see the price adjustment process during the quarterly earnings announcement. The empirical results show that, AAR and CAAR values are positive than negative values for majority of days during the event window. This result shows that market has positively reacted on the release of the September 2012 quarterly earnings announcement. We tested the randomness in the behavior of AAR values using Runs test and found that the observed excess return series are not random during the event window of 61 days for mean adjusted model and market model. The sign statistics shows significant values for overall period for all models and for all the portfolios except for bad news of market adjusted portfolio. Therefore, we conclude that there is a significant difference between the number of positive and negative AAR. The t test results of the study show that AARs and CAARs values are significant for majority of the days in the event window of 61 days. Therefore, we reject the hypothesis that AAR and CAAR values are close to zero. The exception to this conclusion seems to be the bad news portfolio as their values are insignificant for the market adjusted model. The result from Cohen et al. (1983 a) methodology shows the proportionate decrease in beta. The R values are also decreased proportionately during the post event period and this shows poor price efficiency. The BETA2 are negatively signed in the post event period. Based on overall results, we conclude that Indian stock market is inefficient in semi-strong form and there is a scope for abnormal profits for the investors since the market fail to incorporate the new information in security prices. The quarterly earning information can generate significant abnormal profits to the trades in Indian stock market.