Post-Earnings-Announcement drift, Risk premium, Delayed market reaction, Incomplete risk adjustment

Based on stock price behavior around the release of annual reports in 1981 and 1982, Wilson [1987] concludes that for a given amount of earnings, the market reacts more favorably the larger (smaller) are cash flows (current accruals). The goals of this paper are to assess the generality of Wilson's finding and to assess alternative economic arguments that would manifest themselves as a "preference" for cash flows over current accruals. For the overall period, 1977-1984, there Ts no evidence of the simple relation observed by Wilson in his two-quarter test period. We then examine progressively more contextual models of the implications of cash flows and accruals. These models are also unsuccessful in explaining stock price behavior around the release of detailed financial statements. We conclude that either (1) the security price reactions to the release of cash flow and accrual data in financial statements are too highly contextual to be modeled parsimoniously, or (2) important uncertainties about the contents of detailed financial statements are resolved prior to their public release.

[Several studies have hypothesized that economic consequences of mandated accounting procedures arise through impacts on firms' accounting-based loan covenants. However, this research has involved very little direct examination of the loan contracts. This study directly examines how public and private loan agreements were affected by an accounting procedure mandated by the SEC. It analyzes 24 loan agreements of 18 oil and gas firms that, as a result of an SEC requirement announced on May 6, 1986, recorded writeoffs of exploration costs for the first quarter of 1986. The principal finding is that, even for a mandated accounting procedure that caused both large financial statement differences and some technical violations of loan covenants, there were no observable economic consequences for the affected firms. This result casts doubt on the importance of economic consequences of other mandated accounting procedures that might operate through effects on debt covenants.]

[Based on stock price behavior around the release of annual reports in 1981 and 1982, Wilson [1987] concludes that for a given amount of earnings, the market reacts more favorably the larger (smaller) are cash flows (current accruals). The goals of this paper are to assess the generality of Wilson's finding and to assess alternative economic arguments that would manifest themselves as a "preference" for cash flows over current accruals. For the overall period, 1977-1984, there is no evidence of the simple relation observed by Wilson in his two-quarter test period. We then examine progressively more contextual models of the implications of cash flows and accruals. These models are also unsuccessful in explaining stock price behavior around the release of detailed financial statements. We conclude that either (1) the security price reactions to the release of cash flow and accrual data in financial statements are too highly contextual to be modeled parsimoniously, or (2) important uncertainties about the contents of detailed financial statements are resolved prior to their public release.]

Several studies have hypothesized that economic consequences of mandated accounting procedures arise through impacts on firms' accounting-based loan covenants. However, this research has involved very little direct examination of the loan contracts. This study directly examines how public and private loan agreements were affected by an accounting procedure mandated by the SEC. It analyzes 24 loan agreements of 18 oil and gas firms that, as a result of an SEC requirement announced on May 6, 1986, recorded writeoffs of exploration costs for the first quarter of 1986. The principal finding is that, even for a mandated accounting procedure that caused both large financial statement differences and some technical violations of loan covenants, there were no observable economic consequences for the affected firms. This result casts doubt on the Importance of economic consequences of other mandated accounting procedures that might operate through affects on debt covenants.