the incremental information content of non-us gaap earnings disclosures: evidence from uk firms

Journal of International Accounting, Auditing and Taxation15 (2006) 197–214

The incremental information content of non-US GAAPearnings disclosures: Evidence from UK firms

Kingsley O. Olibe ∗Department of Accounting, Texas A&M University-Commerce,

P.O. Box 3011, Commerce, TX 75429-3011, United States

Abstract

This paper examines price and trading volume responses in the US equity market to the preliminaryearnings announcements (PEAs) in the UK of UK firms listed on US exchanges (e.g., NYSE and AMEX).The inquiry focuses on whether the return forecast error (absolute and squared values) and volume residual(standardized and unstandardized) for each day were significantly different from the average on the dayof the earnings announcements (PEA). The most significantly unexpected return occurred the day prior tothe Financial Times (FT) announcement. The results suggest prompt volume and price responses to theUK PEAs in the US security market. Excess trading volume occurred the day prior to and the day of theFT release price response occurred on the day subsequent to the PEAs. This may suggests that investorspossess differential prior beliefs or likelihood functions in evaluating public disclosure. Consistent withFrost and Pownall [Frost, C., & Pownall, G. (1996), Interdependencies in the global markets for capital andinformation: The case of Smithkline Beecham plc. Accounting Horizons, 1, 38–57], US investors seem notto be confused by US/UK generally accepted accounting principles (GAAP) differences, and in fact useinformation about UK GAAP earnings in their valuations and trading decisions. This implies that traderscorrectly use UK accounting output to the determination of values in setting security prices and arriving attrading decisions. Broadly, these findings support the assumption that disclosures by UK-listed firms in theirdomestic market influence share liquidity and trading in the US market.© 2006 Elsevier Inc. All rights reserved.

Keywords: UK preliminary earnings announcements; Information content; Volume and return metrics

1. Introduction

There is considerable empirical evidence that variability of share prices increases (or decreases)when earnings are publicly disclosed to the market (Ball & Kothari, 1991; Beaver, 1968, among

∗ Tel.: +1 903 886 5659.E-mail address: kingsley [email protected].

1061-9518/$ – see front matter © 2006 Elsevier Inc. All rights reserved.doi:10.1016/j.intaccaudtax.2006.08.006

mailto:[email protected]

dx.doi.org/10.1016/j.intaccaudtax.2006.08.006

198 K.O. Olibe / Journal of International Accounting, Auditing and Taxation 15 (2006) 197–214

others).1 Changes in prices and the amount of trading that takes place at the market level provideevidence of information processing by market participants. This paper is an empirical analy-sis of price changes and trading volume of UK firms generally accepted accounting principles(GAAP) preliminary earnings announcements (PEAs) that trade as American Depository Receipts(ADRs).2 If, as prior UK evidence indicates, security price and volume of shares traded do adjustrapidly to PEAs, then observed revision of price and volume of shares traded associated with therelease of PEAs would provide evidence that UK earnings numbers are useful to US domesticinvestors. The PEA, which covers yearly periods, usually contains data on net profits before andafter tax, earnings per share, capital and reserves, dividend per share, and sales turnover (seeAppendix A).

The Security and Exchange Commission (SEC) has expressed concern that diverse accountingpractices around the world may impede US investors’ ability to interpret and process informationof foreign firms that have not been reconciled to US GAAP. The question that logically followsis whether SEC is justified in its concern that US domestic investors need reconciliation data toappropriately interpret earnings reports by foreign registrant (e.g., UK firms). This question isaddressed by evaluating the nature and magnitude of price and volume responses of PEAs in theUS equity market. If US investors have considerable difficulty understanding and interpretingPEAs of UK firms, then the PEAs may not affect markets in the US. On the other hand, if USinvestors have no difficulties understanding the contents of UK PEAs (and PEAs are incrementallyinformative as Brookfield & Morris, 1992 and Firth, 1981 find in the UK equity market) then UScapital market participants should have no difficulty understanding and using UK firms PEAs.

Various studies have examined the capital market effects of non-US GAAP accounting-relateddisclosures in the US and the UK. For example, Frost and Pownall (1994a, 1994b, 2000) exam-ined investors response to earnings disclosed in multiple countries.3 They document that US stockprices respond to earnings disclosed first or only in the US and to information disclosed simulta-neously in both the US and the UK. They find that US capital market participants do not respond toinformation disclosed first or only in the UK. Olibe (2002) assessed the incremental informationcontent of UK government mandated annual general meetings (AGMs). Olibe reports significantmarket reaction in the US in the days surrounding the AGM in UK. Similarly, Olibe and Cready(2003) examined the incremental information content of annual reports and accounts (ARA) ofUK firms. They detected changes in equity prices but no corresponding volume response is foundin the US.

Other studies have also examined the incremental information content of the SEC requiredreconciliation information. Amir, Harris, and Venuti (1993) investigated whether the US GAAPreconciliation data reported in Form 20-F is informative beyond the foreign GAAP disclosuresin explaining returns. No evidence was found that the reconciliation information is related withreturns proximity to the Form 20-F filing date. Further, the Amir et al. (1993) study provides

1 Under the assumption of rational expectations, this is consistent with earnings disclosures possessing incrementalinformation content for market agents and “causing consensus expectations of value-relevant variables” (e.g., cash flows,dividends) and hence the value of shares to be revised.

2 In the UK, firms listed on the stock exchange release their annual financial results in three stages: (1) a preliminaryearnings announcement is made to the stock exchange and to the financial media, (2) some weeks later, these firms releasetheir annual reports and accounts, and (3) later, firms conduct their annual general meetings. Some firms may also releaseinterim earnings. Interim earnings announcements cover quarterly or (more usually) half-yearly periods. Britain’s financialservice authority (FSA) requires all listed companies to submit semi-annual reports.

3 Frost and Pownall (2000) find that the majority of firms that are cross-listed in both UK and the US disclose informationsimultaneously, although some firms disclose first or only in the UK prompting this study’s sample size.

K.O. Olibe / Journal of International Accounting, Auditing and Taxation 15 (2006) 197–214 199

mixed results for the association between the reconciliation data and stock returns measuredover 18-month period. Alford, Jones, Leftwich, and Zmijewski (1993) assessed the informationcontent and timeliness of earnings from US- and foreign-based firms. They found differences inthe information content and timeliness of accounting earnings between US and foreign GAAPs.Similarly, Rees (1995) using event study methodology evaluated the information content of the USGAAP reconciliation by investigating price response around the filing days of 20-F with the SEC.He found finds evidence consistent with the SEC’s position that US GAAP accounting systemprovides incremental information to the market. Further, Rees and Elgers (1997) extend Amir etal. (1993), work by using “retrospective reconciliations information” to investigate income andequity data in initial registrations of non-US firms. Their results seem to be inconsistent with theSEC’s position of requiring non-US firms to supply US GAAP disclosures.

Recently, Lang, Lins, and Miller (2003) examined the relationship between cross-listing inthe US and the information environment of non-US firms. Using firms from 28 countries, theydocument that firms that cross-list on US exchanges enjoy greater analyst following, increasedforecast accuracy and higher market capitalization than non-cross-listed firms. Three possibleinferences could be drawn from Lang et al. findings: cross-listing is beneficial to the firm asevidenced by—(1) greater analyst following, (2) increased capitalization, and (3) abridged forecasterror.

The studies cited above examine the information content of non-US GAAP disclosures andthe value-relevance of SEC Form 20-F reconciliation data. They find that some disclosures areinformative, while others are not. With respect to Lang et al.’s study that addressed the ben-efit issue of cross-listing, this study focuses on whether US investors use UK firm’s PEAs toestablishing values in security prices and arriving at trading decisions. The very existence of UKfirms disclosing preliminary earnings is evidence that there may be a flow of company earningsinformation impacting the market, but despite the policy implications for regulators, there is littledirect empirical evidence that US capital market participants indeed use the PEAs in their val-uation and trading decisions. It is therefore to address this issue that this study (reported here)was undertaken. Analyzing the PEA of UK firms is justifiable because of the close economicinterdependence between the US and the UK. Research examining the information content ofthe PEAs has been directed towards UK market. Most prior UK studies tend to be based on UKdata, albeit, sampled for different periods. Thus, the examination of data derived from differentmarket is desirable from the view point of producing external validation of previous UK results.The inclusion of volume analysis will add an extra dimension to this literature and provide a basiswith which future research can be compared. Volume effects of UK firms in the US may yieldinsight into the extent to which accounting-related disclosures prompt investors to trade. Afterall, such evidence would give a better understanding of the ways in which the market processesinformation. Knowledge of the degree to which the PEA affects share price and trading volumeis important to those interested in corporate reporting, cross-listing regulations as well as thoseinterested in stock market behavior.

Foreign firms’ disclosure practices are increasingly important as trading in non-domestic equi-ties grow worldwide. For example, annual trade volume in foreign equities on major internationalequity markets increased from US$ 460 million in 1992 to US$ 2352 million in 1997 (FIBV,1998; Frost & Pownall, 2000). In addition, equity market regulators and investors are increas-ingly cognizant of, and concerned with, disclosure issues of foreign entities whose shares tradein the US equity markets. In 1997 and 1998, at least 50% of the 50 members of the InternationalFederation of Stock Exchanges (FIBV) “instituted innovations in disclosure rules, enforcement,and/or dissemination” most which focus on disclosure rules (Frost & Pownall, 2000, p. 98).


If markets are completely integrated, cross-listing a firm’s equity in other markets shouldhave no impact on share prices, since investors could presumably undertake such financialmarket transactions directly and efficiently, without the firm acting on their behalf. Arbitrage,in short, will keep expected returns in line with risk. However, when barriers to investmentexist—where such barriers would typically result from exchange rate concerns or some othertransaction and information acquisition costs across borders, regulatory barriers, different taxand accounting standards affecting transactions in securities, cross-listing the firm’s equity in aforeign market is likely to change equilibrium asset prices for the firm. Moreover, it has beenargued that cross-listing could cause a stock to migrate from “low information” setting to “highinformation” environment, thereby lowering risks and hence, expected returns (Barry & Brown,1985).

This study posits that observable return and volume responses changed during the days aroundthe PEAs in the US equity market. A market model approach is employed to estimate unexpectedreturns. Price response to the PEA is measured using both absolute value and squared unexpectedreturns. Abnormal trading volume is estimated via market model regressions. The empiricalinvestigation is based on a sample of price and volume reactions by 80 firm-year observationscovering the period 1996–1998. Restricting the sample to one-equity market controls for marketinstitutional features that can otherwise impact price and trading formation, and inferences drawnfrom the analysis. The disadvantage of limiting the sample to only UK firms is that this yields arelatively small sample and the results are country specific, as they will depend upon the extentof and specific differences between domestic and US GAAP. The results are similar to thosereported in other studies undertaken in the UK and suggest that the PEA contain significantresidual information.

The remainder of the paper is structured as follows. Section 2 discusses background informa-tion and US–UK GAAP differences. Section 3 describes volume as a market response measure.Research design and data source are discussed in Section 4, while Section 5 presents the empiricalresults. Concluding remarks appear in Section 6.

2. Background information and US–UK GAAP differences

2.1. Background information

The globalization of international equity markets in recent years is reflected in the surge offoreign firms that list their common shares directly or through American Depository Receiptson the US exchanges. The volume of foreign shares reached US$ 687 billion in 1998 on theNew York Exchange.4 At the National Association of Security Dealers and Quotation system(NASDAQ), the volume of ADRs totaled US$ 273 billion in 2000.5 In the past, US investorstypically acquired foreign stocks in that firm’s home market. Since many foreign firms now havetheir equity securities listed on the US stock market, US investors can trade in foreign stocks inthe US market. From the standpoint of US capital market participants, having a stake in the capitalof foreign firms expands their investment opportunity set, and thus reduces the “risk premia” thatwould have been available in the firms home markets.

The basis of trade is mostly an ADR, a negotiable certificate created when a foreign firm’sshares (or debentures) are deposited with a US depository bank. The bank holds these Amer-

4 New York Stock Exchange 1999 Fact Book.5 See http://www.nasdaq.com.

http://www.nasdaq.com/


ican Depository Receipts and issues ADRs representing some multiple of one issued share,known as the ADR ratio. The ADR device represents an effective and attractive option forportfolio diversification for US investors, and it also brings benefits to the foreign issuers.6

Analyzing financial disclosures of UK firms is justified because of the close economic inter-dependence between the US and the UK. As US investors diversify their portfolios in UK firms,it seems sensible to assess whether they use non-US GAAP disclosures in making investmentdecisions.

2.2. UK and US general accepted accounting principles differences7

There are important differences between US and UK GAAP that may create difficulties forusers when they are interpreting financial statements prepared following GAAP that is differentthan the GAAP that is used in their home country. “US GAAP and UK GAAP differ significantlyprimarily due to the size of the economies, legal and cultural structures, in the degree of theirmonitoring and enforcement, and in their differing abilities to tolerate vagueness” (Reinstein &Weirich, 2002, p. 64). While many of the differences between US and UK GAAP have beenbridged through the convergence project between the International Accounting Standards Board(IASB) and the Financial Accounting Standards Board (FASB), important differences still remain.The following discussion highlights some of the major differences between UK and US GAAP.A potential market participant must be cognizant of these differences when assessing marketand operating performance of UK versus US firms. The major accounting treatments betweenthe UK and US are more pronounced in the area of goodwill, impairment of goodwill and long-lived assets, financial instruments, inventories, debt, deferred taxes, and defined benefit pensionplans.

2.2.1. Fixed assetsWith respect to fixed assets, the UK never had an accounting standard in this area until Financial

Reporting Standards (FRS) 15, Tangible Fixed Assets, was issued in February 1999. The CompanyAct 1985 permitted a variety of approaches to valuation in which firms has discretion to revalueassets—downward or upward. Camfferman and Cooke (2002) find that approximately 26.1% ofUK firms revalued assets during the year. In contrast to the UK position on fixed assets, US GAAPprohibits upward reevaluation of fixed assets. In the US, the basis of valuation for property, plant,and equipment is usually historical cost.

2.2.2. IntangiblesBefore 1998, the UK allowed goodwill to be written off directly to shareholders’ equity, and

this was normally the way it was done. However, UK firms must now capitalize goodwill withtransitional rules permitting the old goodwill to remain in shareholders’ equity. Prior to 2001,US GAAP treated goodwill like other intangible assets and capitalized it and amortized it overa period not to exceed 40 years. In June 2001, the following two FASB statements were issuedthat changed the US GAAP treatment of goodwill: FASB Statement No. 142, Goodwill andOther Intangible Assets, was issued that eliminated the amortization of goodwill and subjected

6 In a survey of the academic literature, Karolyi (1998) finds that listed foreign firms in the US have noted a declinein their domestic market risk and diminishing costs of capital, increasing the liquidity of the trading shares due to highlyliquid secondary market such as the NYSE.

7 I thank the referee for suggesting the inclusion of this section in the analysis.


it to a new two-step impairment test; and FASB Statement No. 141, Business Combinations,addresses financial accounting and reporting for goodwill and other intangible assets acquiredin a business combination at acquisition. UK firms may carry development costs as an asset,but US rules prohibits carrying development costs as an assets. The US and UK treat also theimpairment of assets differently. In the US, impaired assets are assets whose book value exceedsthe undiscounted net cash flows that the asset is expected to produce. The measurement of theamount of this impairment is based on the fair value of the asset. Any recorded impairment ispermanent in nature and is never reversed. The UK system does allow reversals of for goodwill andintangible impairment by allowing these to be adjusted to fair market values as either an increaseor decrease in their recorded amounts. In the US, interest costs incurred during the period of anasset’s construction is capitalized, while in the UK, the interest capitalization is optional and itmay be expensed as incurred.

2.2.3. InventoriesIn the UK, inventories are carried at the lower of cost or net realizable value (LCM). Unless

specific identification is practicable, cost is generally determined on the first-in, first-out (FIFO)or average method. In the UK, the most popular method of determining the cost of inventoriesis FIFO. The “last-in, first-out” (LIFO) is not permitted. In the US, valuing inventories on LIFObasis is acceptable basis for cost. In the US, Statement of Financial Accounting Standards (SFAS)No. 151, inventory costs an amendment of ARB No. 43 was issued in November 2004 to clar-ify the accounting for abnormal amounts of idle facility expense, freight, handling costs, andwasted material. Under ARB No. 43, these costs were generally treated as a part of the inven-tory unless they were so abnormal that they were required to be treated as a current expense.However, under the new requirement, all of these items be recognized as current-period chargesregardless of whether they meet the criterion of “so abnormal” that was previously applied. ThisStatement is effective for inventory costs incurred during fiscal years beginning after June 15,2005.

US GAAP permits deducting acquisitions of an entity’s own shares (i.e., treasury stock)from stockholders’ equity. UK GAAP prohibits firms from holding such shares relative toemployee share option plans, and records such purchases of shares as balance sheet fixedassets.

2.2.4. Defined benefit pensionsDifferent from UK standards, US GAAP uses an “actuarial approach” to focus on long-term

valuation assumptions for assets and liabilities. It generally uses current market rates for highquality corporate bonds to discount the obligations and the market values for the assets andfocuses on variations falling within certain limits, called a “corridor”. In the UK all variations fromregular costs are allocated over the employees’ remaining working lives (Reinstein & Weirich,2002).

2.2.5. Research and development costsThe US GAAP permits the expensing of both research and development costs. In contrast,

UK GAAP expenses research costs and permits deferring and amortizing development costs ifgrounds exist to expect future revenues to cover such costs. With respect to debt, the UK and UStreat the maturity classification of debt differently. Unlike the UK GAAP, US GAAP can reclassifyshort-term debt as long-term debt on the basis of a post-balance sheet long-term financing. USrules provide “copious guidance on the extinguishment of debt and often require treating all


gains or losses as extraordinary items”. UK guidance is much briefer, generally prohibiting suchclassifications as extraordinary (Reinstein & Weirich, 2002, p. 64).

As Frost and Pownall (1994a, 1994b) point out, these differences may be attributed to thedegree of frequency of mandatory and voluntary accounting disclosures between US and theUK. This variation reflects both differences in disclosure rules and significant differences inthe frequency and timing of voluntary disclosures in the two countries. In general, US firmsare reputed to make more voluntary disclosures than firms from UK, regardless of domicile.Frost and Pownall attributed the greater disclosure practices in the US to both SEC monitoringand enforcement stringency, resulting in higher level of investor confidence on the reliabilityof US accounting system. The greater frequency of disclosures in the US relative to thosein the UK may suggest that US equity markets dominated by retail investors’ demand morepublic disclosures than their UK counterpart. It may also “indicate that managers believe thatUS share prices will be more responsive to new accounting-related disclosure than will UKshare prices”, a concept consistent with the expectation hypothesis (Frost & Pownall, 1994a,1994b, p. 62). Understanding the differences is likely to assist financial statement preparesand users from mistakes in investment and trading decisions based on simplistic assump-tions about the statements. Knowledge of these differences can aid investors, analysts, amongother make sound decisions related to valuations effects, accuracy and timeliness of disclo-sures. To summarize, the differences noted here only relates to the empirical study period(1998).

3. Trading as a market response measure

Beaver (1968) who introduced volume-based event study designs, asserts that volumereflects the sum of all individual investors’ trading activity in the market while price reflectsan averaging of investors’ beliefs. Thus, Beaver argues that if new information changesthe expectations of individuals without altering the expectations of the market as a whole,shifts in individual portfolio holdings will result. Consequently, there will be transactionvolume, but no corresponding price response. Kim and Verrecchia (1991) formalized Beaver’sassertion and demonstrate that the summation process establishing trading volume reflectsdifferences in investors’ beliefs that are cancelled out in the averaging process leading toequilibrium price. Kandel and Pearson (1995) suggest differential interpretation of publicsignals as a plausible explanation for the empirical observation of significant unexpectedvolume around anticipated public disclosures even when prices do not change in response to thedisclosure.

Karpoff (1986) develops a theory of trading volume based on heterogeneous investors whoperiodically and idiosyncratically revise their beliefs or expectations. Karpoff shows two distinctways in which the arrival of new information (e.g., preliminary announcements in the context ofthis paper) affects trading volume. Karpoff shows that a volume increase indicates that investorshave prior belief heterogeneity and/or interpret information differentially.8 The underlying intu-ition is investors’ trade with each other when they disagree about the value of an asset until suchtrading brings price into a competitive equilibrium. Disagreement among agents about the valueof an asset can arise because of heterogeneity in prior beliefs or differential interpretation. The

8 Karpoff (1986) defines differential interpretation as the differential belief revision across individual market participantsas a result of observing a common public disclosure.


differential interpretation could be due to differential expertise and accounting system knowledge.For example, each agent could (and probably does) uniquely predict future cash flows for a firmbased on the same preliminary earnings. In addition, different components of the PEA may lead todifferential assessment of the permanent/transitory features of PEA. In sum, the primary reasonsfor trade are heterogeneous prior beliefs and differences in investors’ differential interpretationof accounting-related disclosures.9

4. Research method

Price statistics reflect changes in the aggregate market’s average beliefs, while trading volumeis the sum of all investors’ trades (Beaver, 1968; Kim & Verrecchia, 1991). Volume of sharestraded and return are complementary measures that capture different aspects of investor responseto information event.10 This paper considers three distinct event period response metrics: (1)absolute return measure, (2) squared return measure, and (3) percentage of outstanding sharestraded (standardized and unstandardized). Employing the two indicators of information content ofa disclosure is justified since there is no necessary reason why the individual and aggregate marketresponse to a public disclosure should be the same. For instance, the aggregate market responseto a public information may be cancelled out, but it may still stimulate volume response due toinvestors’ heterogeneous expectations, opinion changes, economic positions, and/or changes inrisk preferences.

4.1. Unexpected stock return method

Price response to the PEA is measured using scaled squared value unexpected returns (UR2).The market model is estimated for each firm using daily data and is used to form daily unexpectedreturn (UR).11 Squared standardized unexpected return (SUR) is then estimated for each firm on adaily basis following Cready and Mynatt (1991). “The expected value of SUR is equal to 1.0 in caseof no price response” (Cready & Mynatt, 1991, p. 295). May (1971) introduces absolute returns asa measure of market response to interim earnings announcements. Subramaniam (1995) suggeststhat absolute return is more powerful than squared return metric in detecting price response.Accordingly, this paper also employs absolute value unexpected return (ABUR) in assessing priceresponse to the PEAs. Both methods remove directionality from the returns and allow aggregation

9 Other reasons for trading include endowment differences, trading for liquidity, risk tolerance, tax, and portfoliorebalancing considerations.10 Cready and Hurtt (2003) find the relative magnitudes of price and volume responses to information events are suffi-

ciently independent of each other. Kandel and Pearson (1995) report that trading volume around earnings disclosure is, onaverage, unexpectedly high even for a disclosure that induces negligible return reaction. If return and volume measuresare complementary, tests of market response based on both metrics should be more precise than tests based on eithermetric alone. Supplementing a return-based analysis with a volume-based analysis increases the likelihood of correctlyrejecting the null hypothesis of investors’ non-response to the UK firms’ preliminary earnings releases.11 Ordinary Least Squares (OLS) is used to estimate the parameters of the model. Brown and Warner (1985) support the

use of OLS for estimating unexpected returns even in the presence of non-synchronous trading. Non-synchronous tradingis not expected to be a problem for the sample firms because the sample firms are mostly larger given to their marketvalues. Both price and volume models are estimated over a 200-day period, days −210 to −11, relative to preliminaryearnings release. The model is estimated using CRSP equally weighted market index.


of the measure across firms with positive and negative unexpected returns.

ABURit =( |URit| − ABURit

SABRit

)(1a)

SURit =[

UR2it

SABRit

](1b)

where ABURit is the mean absolute value of the residuals for firm i from the market modelestimation period, and SABRit is the standard deviation of the absolute values of the residuals forfirm i from the market model estimation period. To determine whether unexpected return (URit)is based on actual market reaction or merely noise, one has to subtract mean absolute value of theresiduals (ABURit). The use of non-directional return metrics is consistent with Cready and Hurtt(2003) finding that non-directional return metrics is more powerful in detecting investor responseto earnings disclosures than directional return metrics.

4.2. Abnormal trading volume response measure

In the second part of this research, the trading volume response to the PEA of UK firms in theUS market is examined. Trading volume is the sum of all individual investors’ trades, or actionsin the market (Beaver, 1968; Kim & Verrecchia, 1991). Trading volume in the PEA disclosureperiods is measured as the percentage of firm i’s shares traded on day t (Vit), cumulated over a21-day period (t = −10 to +10) and for multi-day trading period activity. Day 0 is the date of thePEA as reported in the London Financial Times Index. Research by Cready and Mynatt (1991)used the number of transactions to measure trading activity. This paper reports on the percentageof shares traded because the setting of Ajinkya and Jain (1989) and Beaver (1968) are robust inthe use of percentage of share measures. Accordingly, the expected volume of shares traded, V,is estimated from the following time series regression12:

Vit = αi + βi ln(VMKTt/OSMKTt) (2)

where Vit is the natural logarithm of daily trading volume for firm i in shares (V) divided by thenumber of shares of firm i outstanding in period t, times 100; VMKTit the total daily tradingvolume for all NYSE firms on day t times 100; OSMKTi the total number of shares outstandingfor all NYSE firms on day t; αi and βi the estimated regression intercept and slope coefficients,respectively; and εit is the volume residual for security i at time t.

The regression is estimated subject to first-order serial correlation (see Cready & Mynatt,1991). Abnormal (unexpected) trading volume (UV) is then estimated on a daily basis as:

UVit = Vit − V̂it

ST̂Di

(3)

12 Outstanding shares data are obtained from the daily CRSP master which incorporates all changes in number ofoutstanding shares, including stock dividends and splits. Volume is traditionally scaled by outstanding shares (e.g.,Beaver, 1968; Cready & Mynatt, 1991). Ajinkya and Jain (1989) suggest the use of the logarithmic transformation.


Table 1Preliminary earnings release date selection criteria (fiscal year 1996–1998)

Initial sample of 47 firms per year obtained from global researcher 141Unable to locate in CRSP data base (26)Unable to find preliminary earnings release date (32)Fewer than 221 observations (3)Final sample 80

The sample consist of 108 preliminary report dates 32 of which are for the 1996 fiscal year, 37 which are for 1997 fiscalyear, and 39 which are for the 1998 fiscal year.

Table 2Sample description

Variable Mean Standard deviation Minimum Maximum

Average daily firm common shares outstanding 27.6295 48.3274 0.2470 213.4129Average daily percentage volume 0.1352 0.7899 −99.0000 12.068Average daily return 0.0011 0.0059 −0.3318 0.0235Market value at year-enda (in millions) 10,671.91 2562.15 33.77 75,653.44Number of days before interim disclosureb 32.1 9.7 23 59

a Market value of equity is defined as the end of the year share price times the number of shares outstanding in millionsof dollars.

b These are number of days in which PEA precedes interim disclosures.

where ST̂Di is the residuals’ estimated standard deviation for firm i from Eq. (2) and V̂ is obtainedfrom the structural portion of Eq. (2).13 Unexpected volume (UV) is estimated via market modelregressions. Significant positive values for UV would indicate US investors traded based on UKPEAs. Trading days less than 221-day estimation periods are excluded to enhance inter-transientcomparability of trading activity. The results from the analysis are presented in Table 1. To controlfor the effect of serial correlation in Eqs. (2) and (3), an autoregressive (Prais–Winsten) procedureestimator method is used.14 The wider day-by-day and multi-day period is employed becauseunexpected trading can persist up to 5 days after earnings announcements.

4.3. Data source

The sample used in this study consists of firms registered in the UK and listed on theNYSE/AMEX during 1996–1998, with sponsored ADRs. The 3 years chosen were felt to berepresentative of US stock exchange behavior. The daily closing returns and the number of sharesoutstanding for the sample firms are obtained from daily CRSP tapes. PEA event dates are clas-sified as the date of FT publication and are obtained from the London Financial Times Index.15

13 Following Cready and Mynatt (1991), only the structural portion is used because of the multi-day nature of theanticipated trading response. Specifically, if positive unexpected trading occurs on event day t and serial correlation ispositive, expected trading on day t + 1 may be biased upward. Failure to account for the serial correlation raises the noiselevel of the unexpected trading measure.14 The autoregression estimation employs Prais–Winsten estimators in an approach very similar to the Cochrane–Orcutt

procedure.15 In the US, foreign and domestic firms typically disseminate earnings news via press releases to various news agencies,

including Dow Jones for inclusion in The Wall Street Journal and the Broad Tape. I searched full text on Dow Jones NewsRetrieval Service (DJNRS) from 1995 to 1997 to examine if UK PEAs are disclosed in the US at the same dates as in theUK. This search produced no evidence of such disclosure.


Firms are identified using: (1) Lexis Nexis and (2) reference to the annual editions of the NYSEFact Book. Firms are deleted from the sample if: (1) a firm’s volume statistics are not availableon the CRSP tapes, or (2) PEA disclosure dates are not available. The final sample consists ofpreliminary report dates, 23 of which are for the 1996 fiscal year, 30 of which are for the 1997fiscal year, and 27 of which are for the 1998 fiscal year. The Dow Jones Retrieval Service issearched to identify US disclosures.

5. Analysis and results

5.1. Descriptive statistics

Descriptive statistics for the sample are presented in Table 2. Since the sample selection criteriaresult in only firms with NYSE/AMEX listings, the sample firms are above average in their equitymarket values relative to all publicly traded stocks. The mean size is US$ 10,0671.91 million.However, the large standard deviation (US$ 2562.15) of the sample distribution of market valuesand the minimum and maximum market values of equity of the sample firms suggest there isconsiderable variation in firm size within the sample.

5.2. Price response

Table 3 reports statistics from the 21 daily event time regressions on both mean squared andabsolute value standardized unexpected return measures relative to the PEA dates. The squaredprice response measure is significantly different from 1.0 on day t = −1. The absolute value priceresponse measure is significantly different from 0 on day t = −1. There is no clear evidence ofunusual mean unexpected returns on days t = 0 and +1. No evidence of delayed or early US marketreaction is detected, indicating the US market is signal efficient. The price responses noted ondays t = −8 and −4 may be due to information leakage/misspecification or price irrelevant noise.

Columns 3 and 8 report the standard deviation of returns on each event day. The standarddeviations of returns increase during the earnings announcement period, as first observed byBall and Kothari (1991), Beaver (1968), and Cready and Mynatt (1991). The standard deviationsuggests that price adjustments for some firms are relatively high while others are limited. The15.303 (1.8632) standard deviation of squared (absolute) value unexpected returns on day t = −1is 6.431 (2.034) times the 20-day average of 2.330 (0.916) for these firms excluding day t = −1.Compared to other days, this implies a greater relative amount of information processing and usageby investors on day t = −1. The price analyses indicate that UK GAAP accounting measures donot impede US market investors’ ability to use UK firms PEA in valuing the firm’s stocks. Thisimplies that traders correctly use UK accounting output to the determination of values in settingsecurity prices and arriving at trading decisions.

Fig. 1 summarizes the distribution of abnormal return performance for the window from days−10 to +10. Plotting the mean behavior of daily returns on normal graph indicate that bothmean squared and absolute standardized values of unexpected returns were leptokurtic. That is,there appears to be a sharp increase in the mean values of unexpected returns around preliminaryannouncements, with most of the increase being confined to day t = −1. In the pre-announcementperiod it appears that there is a tendency for volatility to be lower than the immediate days aroundthe release of preliminary earnings. The findings in Table 3 and Fig. 1A and B jointly suggestsignificant price responses are associated with UK PEAs.


Table 3Daily mean squared standardized unexpected returns and mean absolute value standardized unexpected returns at PEAdates

Days relative toPEAa (date)

Squared unexpected returnsb Absolute value unexpected returnsc

Mean S.D.d T-value Prob > |T| Mean S.D. T-value Prob > |T|−10 0.2931 1.3178 1.9891 0.0500 −0.1811 0.8221 −1.9707 0.0523−9 0.0318 1.8030 0.1577 0.8751 −0.0063 0.9662 −0.0582 0.9537−8 0.2776 1.0891 2.2794 0.0253** −0.1257 0.8196 −1.3719 0.1740−7 0.0954 1.4282 −0.5978 0.5517 0.0294 0.8188 0.3207 0.7493−6 0.0014 2.0169 −0.0061 0.9951 0.0167 0.9895 0.1506 0.8806−5 0.4447 3.6927 1.0772 0.2847 0.0989 1.1820 0.7487 0.4562−4 0.4397 2.4460 1.6078 0.1119 0.2811 1.0373 2.4236 0.0177**

−3 0.0956 1.7999 0.4752 0.6360 0.1085 0.9209 1.0541 0.2950−2 0.1193 1.8993 0.5581 0.5783 0.1041 1.0121 0.9146 0.3632−1 3.8919 15.3038 2.2746 0.0256** 1.0254 1.8632 4.9223 0.0001***

0 1.0673 9.4581 1.0093 0.3159 0.1803 1.1726 1.3752 0.17301 0.1410 1.8308 0.6887 0.4930 0.1319 0.9988 1.1807 0.24132 0.0097 1.6833 −0.0516 0.9589 0.0120 0.9257 0.1162 0.90783 0.1945 1.2711 1.3684 0.1751 −0.0676 0.8516 −0.7104 0.47954 0.1436 2.2624 0.5215 0.6035 0.0564 1.0041 0.5021 0.61705 0.3062 1.1717 2.3375 0.0219** −0.1284 0.7498 −1.5319 0.12956 0.0843 1.5931 0.4730 0.6375 −0.0563 0.9737 −0.5176 0.60627 0.0160 1.8293 −0.0781 0.9380 0.0319 0.9252 0.3082 0.75888 0.0006 2.6587 0.0019 0.9958 −0.1068 1.0242 −0.9326 0.35399 0.0959 2.4106 0.3557 0.7230 0.0501 1.0071 0.4453 0.6573

10 0.2099 2.9394 0.6388 0.5248 0.0385 1.1077 0.3112 0.7565

Multi-day window*** UR SQ CAR UR-ABS CAR

Mean S.D. T-value Prob > |T| Mean S.D. T-value Prob > |T|−1 to +0 4.4255 20.2214 2.7683 0.0063*** 1.1155 2.2863 6.1716 0.0001***

−1 to +1 4.6504 21.6022 3.3350 0.0010*** 1.1895 2.4913 7.3968 0.0001***

Notes: Research by Patell (1976), Marais (1985), and Lobo and Mahmoud (1989) report squared return means of lessthan one. Cready and Mynatt (1991) report squared means that exceed one. This study reports squared means less thanone. This is particularly relevant as it corroborates Patell (1976), Marais (1985), and Lobo and Mahmoud (1989). Thistable reports mean unexpected for squared and absolute value returns for days t = −10 to +10. The reported test statisticis a test of the null hypothesis that unexpected return equal zero for day t. The returns are equally weighted from CRSP.

*Significant at the 1% level (one-tailed cross-sectional t-test).** Significant at the 5% level (one-tailed cross-sectional t-test).

*** The multi-day period mean cumulative unexpected returns are statistically significant at the 1% levels.a The preliminary earnings announcements dates are from London Financial Times Index.b Squared standardized unexpected returns are calculated to have an expected value of 1.0 in the absence of price

variance.c Absolute value unstandardized unexpected returns are calculated to have an expected value of zero in the absence of

price variance.d Days t = −1 and 0 squared returns are abnormally large, which account for the increased standard deviation on days

t = −1 and 0.

The mean squared value multi-day returns measure is significantly different from 1.0 on dayst = −1 to 0, −1 to +1, −1 to +2, and −10 to +10. The multi-day mean absolute value abnormalreturns response measure is significantly different from 0 on days t = 1 to +0, −1 to +1, −1 to+2, and −10 to +10. Overall, however, the results are in line with the findings of previous second


Fig. 1. (A) US market reaction around UK earnings announcement (PEA) and (B) graph of mean squared returns.

moment research, e.g., Brookfield and Morris (1992) and Firth (1981) for the UK, and suggestthe PEA to contain significant residual information.

5.3. Abnormal trading volume

Table 4 reports statistics from 21 daily and multi-day mean abnormal percentage of sharestraded (UV) relative to the preliminary earnings announcement dates. The 21-day examinationperiod is employed to capture disclosure-induced trading in its entirety because all trading activ-ity is not expected to occur immediately upon release of an information event. Market efficiency


Table 4Daily mean unstandardized unexpected volume and standardized unexpected volume at PEA dates

Day t Number ofreleasea

Mean actual less expected volume

UnstandardizedUVb

T-values P-value StandardizedUVc

T-value P-value

−10 80 −0.1821 −1.6803 0.0978 −0.1967 −1.0039 0.3192−9 80 −0.3159 −2.8297 0.0061 −0.4931 −2.4167 0.0184−8 80 −0.2775 −2.5155 0.0143 −0.3860 −2.5076 0.0145−7 80 −0.0120 −0.1074 0.9148 −0.1848 −1.0782 0.2848−6 80 0.0296 0.2594 0.7961 0.0564 0.3763 0.7079−5 80 −0.0225 −0.1828 0.8555 −0.1351 −0.7351 0.4650

−4 80 −0.1807 −1.3952 0.1676 −0.3753 −2.1831 0.0325−3 80 −0.0817 −0.6502 0.5178 0.0883 0.2527 0.8013−2 79 −0.0217 −0.1934 0.8472 −0.0101 −0.0568 0.9548−1 80 0.3018 2.2451 0.0279** 0.6532 2.9585 0.0042*

0 80 0.2725 1.8618 0.0671*** 0.4427 2.1573 0.0346**

1 80 0.1147 0.9479 0.3466 0.2025 1.1273 0.26362 80 −0.0642 −0.5323 0.5964 −0.1240 −0.6311 0.53023 80 −0.1956 −1.4558 0.1503 −0.2149 −1.0559 0.29504 80 −0.0601 −0.4282 0.6699 −0.1616 −0.8079 0.42205 80 0.1216 0.8930 0.3750 0.3516 1.1381 0.2591

6 80 0.0051 0.0389 0.9690 −0.1584 −0.7767 0.44017 80 −0.0344 −0.2734 0.7856 −0.0730 −0.3635 0.71748 80 −0.1773 −1.3957 0.1674 −0.0402 −0.1994 0.84259 80 0.0018 0.0170 0.9865 −0.1209 −0.6232 0.535410 80 0.0044 0.0373 0.9703 −0.1580 −0.7004 0.4862

−1 to +1 80 0.2308 2.9840 0.0032** 0.4370 3.7162 0.0003*

−1 to +2 80 0.0912 1.5323 0.1264 0.2020 2.2042 0.0282*

−1 to +5 80 0.0742 1.4609 0.1447 0.1724 2.0464 0.0413*

R2 = 0.1670; UV: unexpected trading volume.a The preliminary earnings release date is London Financial Times Index.b These are residuals from the structural portion of a first-order autoregressive model on market volume.c These are deflated residuals from the structural portion of a first-order autoregressive model on market volume.* Significant at 1% level (one-tailed cross-sectional t-test).

** Significant at 5% level (one-tailed cross-sectional t-test).*** Significant at 10% level (one-tailed cross-sectional t-test).

with respect to public disclosure refers to aggregate market behavior (price) and not to individ-ual traders. The unstandardized unexpected volume (UV) measure is significant on days t = −1(5% level) and t = 0 (10% level). The standardized unexpected volume is significant on dayst = −1 (1% level) and t = 0 (5% level). No evidence of differential volume and price responses isfound.

Fig. 2 plots the behavior of trading volume for the 21-day event period and in Table 4,the results are tabulated. The results indicate that generally there appears to be sharp increasein trading around earnings announcements period, with most of the increase being confinedto days −1, 0, and +1 for both standardized and unstandardized forecast errors. Clearly, theresults in Table 4 and Fig. 2A and B jointly suggest significant trading activity accompany PEAs.Broadly, this findings support the assumption that disclosures by UK-listed firms in their domes-


Fig. 2. (A) Graph of trading volume around UK earnings announcements (PEA) and (B) graph of trading volume aroundUK earnings announcements (PEA).

tic market influence share liquidity and trading volume in the US markets where their sharestrade.

6. Conclusions and implications

This study provides empirical evidence on US domestic investors’ response to non-US GAAPearnings initially and/or disclosed only in the UK. Unlike prior research in this subject, I employboth price and trading volume metrics to assess the informativeness of UK preliminary earnings


disclosures. As Bamber and Cheon (1995) point out, trading volume and return are complemen-tary measures that capture different aspects of market assimilation and utilization to a publicinformation event. Thus, studies using price as a measure of market response to a disclosure mayalso need to include volume analysis. The volume evidence can also serve as benchmark data thatshould be useful in the design and interpretation of information content applied in an internationalcontext.

In conclusion, the results support the following inferences:

1. Unexpected price response occurred on the day prior to the Financial Times disclosure day(i.e., day t = −1).

2. Unlike price response, significant trading volume occurred on the day of earnings announce-ments (i.e., day t = 0).

3. Although earnings announcements are anticipated to a certain degree by investors, the actualrelease of the data still results in substantial information processing in the US equity market.No evidence of the US market requiring a longer period in which to adjust for the informationcontent of the PEA. The results of the study using daily data reported in this study confirm thefindings of Brookfield and Morris (1992) and Firth (1981), and support the view that investorexpectations are revised continuously. Prior research (e.g., Bamber & Cheon, 1995; Cready& Mynatt, 1991; Kandel and Pearson, 1995) found that trading responses are more easilydetected than price, this analysis seem to suggest that trading volume give similar result as theprice metrics.

The evidence provided extends our understanding of the “usefulness” of accounting-relateddisclosure in an international context. The results have direct implications on the debate related tothe harmonization of accounting principles. The finding that US market participants find the PEAsof UK firms useful indicates that harmonization may not be necessary; however, earning num-bers derived from non-US accounting principles is potentially complex. Therefore, harmonizationof accounting standards is likely to bring benefits to preparers and users of accounting data byminimizing these complexities. In addition, the likelihood that the observed US market responsemay be a reflection of investors’ response in the UK, not necessarily that US market participantsunderstand and use UK GAAP information event. It should be noted that the empirical resultsfound here support, at least in spirit, some of the findings of previous studies focusing on incre-mental information content of non-US GAAP disclosures. The price and volume responses lendsome support to the findings of Frost and Pownall (1996, p. 38) results which suggest that “USinvestors do not appear to be confused by US/UK GAAP differences, and in fact use informationabout UK GAAP earning in their valuations of Smithkline Beechamp shares”. Chan, Fong, Kho,and Stulz (1996) compared the intra-day patterns of US return volatility of US firms with the USreturn volatility of European and Japanese firms that are dual-listed on US exchanges and theirrespective domestic exchange. They found that trading patterns of the Japanese and Europeanshares are similar to that of the US shares. Wahab, Lashgari, and Cohn (1992) find that there is nosignificant difference between the closing stock price of ADRs and that of their underlying shares.Therefore, results from prior studies seem to suggest that the degree of overlapping trading hourshas no effect on the trading of the foreign firm shares on US exchanges.

The findings of this study raise an important research question. Which investor group (individ-ual or institution) in the US find the PEAs informative? A useful extension would be to addressthis question. The use of transaction data enables future research to coarsely address these issues.Given the findings of US domestic investors response to UK firms accounting data, the question


that logically follows is whether the Security and Exchange Commission is justified in requiringUK firms to supply reconciled accounting data. A comparative analysis of the nature and mag-nitude of UK earnings announcements and Form 20-F reconciliations would be instructive. Theanswers to these questions have social and economic implications that should be of interest to theSEC and accounting researchers.

Acknowledgements

The author is grateful to the Center for International Business Studies at Texas A&M Universityfor its financial support. I would like to thank Bob Strawser, William Cready, James Benjamin,and Steve Grossman for their special help on my dissertation from which this paper is derived.This paper has benefited from the insightful comments of Texas A&M University and LouisianaState University workshop participants, Augustine Arize, Bobby Carmichael and Lynn Reese.Helpful comments from two anonymous referees are gratefully acknowledged.

Appendix A

British Airways: preliminary financial results 1997–1998

1998 1997 Change (%)

Turnover (£m) 8642 8359 3.4Operating profit/(loss) (£m) 504 546 (7.7)Profit before tax (£m) 580 640 (9.4)Attributable profit (after Minority Interest) for the period (£m) 460 553 (16.8)Capital and reserves at period end (£m) 3321 2984 11.3

Earnings per shareBasic (p) 44.7 55.7 (19.7)Fully diluted (p) 42.0 50.8 (17.3)

Dividends per share (p) 16.60 15.05 10.3

This is directly derived from the firm’s PEAs data. The PEA data are usually reported in the annual report and accounts.For example, Barclays PLC released its 1997 PEA in UK on December 31, 1997. The annual report and accounts, whichcontain some data from the PEA was posted to shareholders on March 25, 1998.

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the incremental information content of non-us gaap earnings disclosures: evidence from uk firms

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