Investor Inattention and Friday Earnings Announcements

Does limited attention among investors affect stock returns? We compare the response to earnings announcements on Friday, when investor inattention is more likely, to the response on other weekdays. If inattention influences stock prices, we should observe less immediate response and more drift for Friday announcements. Indeed, Friday announcements have a 15% lower immediate response and a 70% higher delayed response. A portfolio investing in differential Friday drift earns substantial abnormal returns. In addition, trading volume is 8% lower around Friday announcements. These findings support explanations of post-earnings announcement drift based on underreaction to information caused by limited attention. ∗DellaVigna is from the Department of Economics, University of California, Berkeley. Pollet is from the Department of Finance, University of Illinois at Urbana-Champaign. A previous version of the paper was distributed under the title “Strategic Release of Information on Friday: Evidence from Earnings Announcements”. We thank John Campbell, David Card, Raj Chetty, James Choi, Kent Daniel, Yonca Ertimur, John Graham, David Hirshleifer, Wei Jiang, Lawrence Katz, David Laibson, Owen Lamont, Ulrike Malmendier, Maria Nondorf, Ashley Pollet, Allen Poteshman, Torsten Persson, Matthew Rabin, Jeremy Stein, Xiao-Jun Zhang, and audiences at Duke (Fuqua), the Hong Kong University of Science and Technology, IIES (Stockholm), London Business School, Northwestern (Kellogg), Stanford University (GSB), University College (London), UC Berkeley, UI Urbana-Champaign, University of Zürich, the Adam Smith Asset Pricing Conference (LBS), the AEA Meetings 2005, the SITE 2004 (Psychology and Economics), and the Yale Conference on Behavioral Science for valuable comments. Jessica Chan, Eric Fleekop, Richard Kim, Clarice Li, Ming Mai, Raymond Son, Matthew Stone, and Terry Yee helped collect the announcement dates from the newswires. Dan Acland, Saurabh Bhargava, and Tatyana Deryugina provided excellent research assistance. Investors have a limited amount of time and cognitive resources to process information. Despite the intuitive appeal of limited attention, little evidence exists on the extent to which the quality of decision-making by investors declines in response to distractions. Incentives, information aggregation across investors, and arbitrageurs may eliminate the effects of limited attention. We examine a decision where attention to new information plays a crucial role, the response to earnings surprises. We compare announcements that occur just before the weekend, on Friday, to announcements on other weekdays. If weekends distract investors and lower the quality of decision-making, the immediate response to Friday earnings surprises should be less pronounced. As investors revisit their decisions in subsequent periods, the information should eventually be incorporated in stock prices. As a result, the delayed response, measured by the post-earnings announcement drift, should be of greater magnitude for Friday announcements. If limited attention, instead, does not affect stock prices, the response to announcements should not differ for Friday and non-Friday announcements. This paper, therefore, addresses the debate on the explanation for the post-earnings announcement drift (Chan, Jegadeesh, and Lakonishok, 1996; Bernard and Thomas, 1989). Behavioral explanations depend on disposition effect (Grinblatt and Han, 2005; Frazzini, 2006), fluctuations in overconfidence (Daniel, Hirshleifer, and Subrahmanyam, 1998), beliefs about mean reversion (Barberis, Shleifer, and Vishny, 1998), or underreaction to information due to cognitive limits (Hong and Stein, 1999). Of the explanations in the literature, only underreaction to information makes the prediction that distractions increase the drift. The paper proceeds as follows. In Section I we present a model of the response of stock prices to signals about earnings. In each period, a share of the agents is distracted and does not observe a signal regarding company performance. Given limits to arbitrage in the form of risk aversion, the distracted agents affect prices. A larger share of inattentive investors shrinks the immediate response and magnifies the delayed response of prices to the signals. Distraction, therefore, increases the post-earnings announcement drift. The combined response to the announcement, however, is not affected by the distracted investors. We also show that companies that maximize short-term share value release bad news on high-distraction days. In Section II, we characterize our sample of earnings announcements from January 1995 until June 2006. Since we analyze the difference between Friday and non-Friday announcements, the accuracy of the announcement date is critical. We devise a rule, based on newswire announcement dates, that identifies the correct announcement date from I/B/E/S and COMPUSTAT data with more than 95% accuracy. This rule can be used to improve the accuracy of the I/B/E/S announcement date from 1984 onward. In Section III, we evaluate the immediate and delayed stock return response to information by comparing the top and bottom quantile of the earnings surprise. The immediate stock re-