Heterogenous Earnings Growth Paths and the Risk Resolution Role of Earnings: An Examination of the Earnings Announcement Risk Premium

Abstract

I establish a link between the heterogeneity in firms’ expected earnings growth paths and theearnings announcement risk premium. My evidence suggests that variation in the expected timing of earnings growth conveys ex-ante information about variation in the expected resolution of uncertainty across stocks that shapes the cross-section of investors’ expected returns around earnings announcements. This return pattern arises cross-sectionally but also within-firm over time as each firm is expected to have its own earnings growth path. Moreover, this return pattern only arises on earnings announcement days and not in non-announcing days, consistent with variation in the earnings announcement risk premium and not another phenomenon. Connecting the risk resolution role of earnings to the magnitude of investors’ expected returns around earnings announcements provides support to accounting theory that establishes a link between information conveyed by financial reporting and risk.