The Effect of Ex Ante Earnings Uncertainty on Earnings Response Coefficients
SYNOPSIS AND INTRODUCTION: This study examines the effect of the uncertainty in analysts' earnings forecasts on the relation between unexpected returns and unexpected earnings. Numerous theorists have considered the effect of uncertainty on firm value, with particular interest in the uncertainty in a firm's future cash flows that underpin firm value. Since accrual accounting earnings represent a theoretical proxy for future cash flows, the effect of earnings uncertainty on firm value is also of considerable interest. However, observed uncertainty in accounting earnings may be attributable to noise (garbling) in the earnings signal or to the fundamental uncertainty of expected future cash flows, or both. Moreover, theory suggests these different forms of uncertainty may have differing effects on firm value. To date, there is little empirical evidence concerning the effect of uncertainty in earnings on firm value. We investigate the effect of ex ante earnings uncertainty by using the familiar linear relation between unexpected stock returns (UR) and unexpected earnings (UE) with 3,167 firm year observations collected over the six year period 1979 84. The variance in analysts' earnings forecasts just prior to a firm's annual earnings announcement is employed as our firm specific proxy for ex ante uncertainty. Our results indicate a systematic relation between ex ante uncertainty and the information content of earnings. A given unit of earnings news has a greater effect on unexpected stock price change as the amount of pre earnings announcement