Implications of Transaction Costs for the Post–Earnings Announcement Drift

Implications of Transaction Costs for the Post–Earnings Announcement Drift ABSTRACT This paper examines the effect of transaction costs on the post–earnings announcement drift (PEAD). Using standard market microstructure features we show that transaction costs constrain the informed trades that are necessary to incorporate earnings information into price. This implies weaker return responses at the time of the earnings announcement and higher subsequent returns drift for firms with higher transaction costs. Consistent with this prediction, we find that earnings response coefficients are lower for firms with higher transaction costs. Using portfolio analyses, we find that the profits of implementing the PEAD trading strategy are significantly reduced by transaction costs. In addition, we show, using a combination of portfolio and regression analyses, that firms with higher transaction costs are the ones that provide the higher abnormal returns for the PEAD strategy. Our results indicate that transaction costs can provide an explanation not only for the persistence but also for the existence of PEAD. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Accounting Research Wiley

Implications of Transaction Costs for the Post–Earnings Announcement Drift

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Publisher
Wiley Subscription Services, Inc., A Wiley Company
Copyright
©University of Chicago on behalf of the Institute of Professional Accounting, 2008
ISSN
0021-8456
eISSN
1475-679X
D.O.I.
10.1111/j.1475-679X.2008.00290.x
Publisher site
See Article on Publisher Site

Abstract

ABSTRACT This paper examines the effect of transaction costs on the post–earnings announcement drift (PEAD). Using standard market microstructure features we show that transaction costs constrain the informed trades that are necessary to incorporate earnings information into price. This implies weaker return responses at the time of the earnings announcement and higher subsequent returns drift for firms with higher transaction costs. Consistent with this prediction, we find that earnings response coefficients are lower for firms with higher transaction costs. Using portfolio analyses, we find that the profits of implementing the PEAD trading strategy are significantly reduced by transaction costs. In addition, we show, using a combination of portfolio and regression analyses, that firms with higher transaction costs are the ones that provide the higher abnormal returns for the PEAD strategy. Our results indicate that transaction costs can provide an explanation not only for the persistence but also for the existence of PEAD.

Journal

Journal of Accounting ResearchWiley

Published: Jun 1, 2008

References

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