Review of Accounting Studies, 8, 69–104, 2003
C
2003 Kluwer Academic Publishers. Manufactured in The Netherlands.
On the Rationality
of the Post-Announcement Drift
A. DONTOH
∗
adontoh@stern.nyu.edu
Department of Accounting, Stern School of Business, New York University, Tish, 40w 4st., 418, New York, NY 10012
J. RONEN
Department of Accounting, Zicklin School of Business, Baruch College, New York, NY 10010
B. SARATH
Department of Accounting, Zicklin School of Business, Baruch College, New York, NY 10010
Abstract. This paper demonstrates that a post-announcement earnings drift, which is often advanced as an example
of market irrationality, can arise even if traders act rationally on their information. Specifically, we show that in the
presence of share supply variations which are unrelated to information, there is a positive correlation between the
unexpected component of current public signals and future price changes. Such a correlation arises from the fact
that while prices reveal private information that cannot be found in public signals, non-information based trading
distorts the information content of prices relative to the implications of both private and public information. Under
these circumstances, markets may appear semi-strong inefficient and slow to respond to earnings announcements
even though information is processed in a timely and efficient manner. Our findings correspond well with previously
documented empirical evidence and suggest that the robustness of earnings-based “anomalies” may be rational
outcomes of varying uncertain share supply.
Keywords: post-announcement drift, earnings announcements, noisy rational expectations equilibrium, non-
information based trading
JEL Classification: M41-Accounting
A number of empirical studies show that risk and/or size-adjusted abnormal returns in
the period following an earnings announcement tend to be positively correlated with the
“earnings surprise” associated with the announcement (see Bernard, 1992a for a survey).
Usually referred to as a “post-announcement drift,” this empirical phenomenon has been
viewed as a market anomaly—i.e., a violation of semi-strong efficiency. Previous attempts to
explain this anomaly have invoked inefficient processing of public information, or some form
of investor myopia.
1
In contrast, we demonstrate that a post-announcement drift can arise
naturally within a “multi-period noisy rational expectations” framework. Consequently, the
existence of a post-announcement drift may not imply investor “irrationality” with respect
to the processing or the usage of information.
For reasons that will be made clear below, the key to understanding post-announcement
drift lies in the fact that equilibrium prices are affected by economic factors other than
information. “Non-information based trading” (NIB) is a fundamental observed feature of
∗
Corresponding author.
@Phil_Robichaud
@deepthiw
@JoseServera