How Do Investors Interpret Announcements of Earnings Delays?

The following post comes to us from Tiago Duarte-Silva of Charles River Associates, Huijing Fu of the Shanghai Advanced Institute of Finance, Christopher Noe of MIT Sloan School of Management, and K. Ramesh, Professor of Accounting at Rice University.

Companies that fail to file a 10-K or 10-Q on time are required by SEC Rule 12b-25 to file a Form NT (NT for non-timely), which provides a narrative explanation for the late filing. No analogous rule exists for earnings announcements, which often precede 10-K or 10-Q filings. For companies that are unable to report earnings by their expected date, therefore, managers face a decision – to keep silent or announce the delay. The SEC has also manifested interest in earnings delays: it recently announced a quantitative model that is expected to supply potential leads to its Division of Enforcement and lists earnings delays as a signal of earnings management.

In our paper, How Do Investors Interpret Announcements of Earnings Delays?, which was recently accepted for publication in the Journal of Applied Corporate Finance, we show that announcements of a delay in the reporting of earnings produce an average one-day abnormal stock return of approximately -6%. So, although announcements of a delay in the reporting of earnings are infrequent, they tend to be associated with a considerable reduction in firm value. In addition, delays precipitated by accounting issues or lacking an explanation result in more negative market reactions than delays related to business events, implementation of new accounting standards, or non-business reasons such as bad weather.

We also document that the market reaction to earnings delay announcements is consistent with these disclosures signaling deteriorating financial performance. So, investors seem to have a good general sense about what these announcements imply for future earnings and can discriminate among the given reasons for the delay.

Besides being of interest to investors, these findings are also relevant to corporate decision makers faced with an earnings delay. Disclosure for unfavorable reasons for the delay could potentially benefit managers by limiting legal exposure and maintaining their firms’ credibility. Managers with more innocuous reasons could also potentially benefit from disclosure because not providing any reason tends to be interpreted as bad news. However, this decision has to be weighed relative to the disclosure costs.

The full paper is available for download here.

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