Information Diffusion and the Boundary of Market Efficiency: Empirical Evidence from Earnings Announcements

This paper tests the implications of an information diffusion model (Lu, 2003) in the quarterly earnings announcement setting. Post-announcement-drift is documented only for earnings announcements that have high information uncertainty, measured by high abnormal trading volume and return volatility surrounding the announcement. The results are robust after controlling for the magnitude of earnings surprise. Preliminary evidence also suggests that the magnitude of drift for good (bad) news firms are positively (negatively) related to analyst following and institutional ownership. Moreover, price movement after a second earnings announcement is affected by the information contained in the previous announcement. These findings are consistent with an information diffusion process at work in capital markets. I would especially like to thank Randy Beatty (Chairman) and K.R. Subramanyam for valuable guidance and many insightful discussions. I acknowledge Mark DeFond, Larry Harris, Raffi Indjejikian and Chuck Swenson for their encouragement and suggestions in this exploratory study. I am also indebted to Rebeeca Hann, Mingyi Hung, Qingzhong Ma, Ted Mock, Jim Manegold, Robert Trezevant, and the participants at the USC accounting research forum for helpful comments on the paper. All errors remain my own responsibility. I acknowledge the financial support and fellowships from the Leventhal School of Accounting, the Marshall School of Business, and the SEC and Financial Reporting Institute.