Liquidity Risk, Investor Flux and Post-Earnings Announcement Drift

Kirsten L. Anderson* Georgetown University Jeffrey H. Harris University of Delaware Eric So Nasdaq Economic Research First Draft: July, 2007 This draft: November 4, 2007

Abstract: We investigate liquidity risk and its relationship to the post-earnings announcement drift for Nasdaq firms. We find that earnings surprises change the composition of investors, with this flux representing liquidity risk to those who might try to trade profitably against predictable drift returns. We characterize the determinants of unexplained volume (SUV) at the earnings announcement and find that both liquidity levels (spreads and volume) and liquidity risk (flux in institutional holdings and retail trading activity) are significantly related to SUV. Our results suggest that investor flux manifest in trading volume (and in opinion divergence more generally) affects post-earnings announcement drift.

JEL Classification: G14, M41 Keywords: Opinion Divergence, Post-earnings announcement drift, Risk, Volume, Volatility

1. Introduction Liquidity risk has been shown to affect asset prices in both Pastor and Stambaugh (2003) and Acharya and Pederson (2005)the average return on stocks with high sensitivities to liquidity exceeds that for stocks with low sensitivities. Individual stock liquidity risk evolves from both firm-specific and market factors, with the link to market characteristics providing an impetus for liquidity risk as a pricing factor. Acharya and Pederson find that the most important source of liquidity risk is the covariance of individual stock liquidity with market returns, so that investors value stocks that are liquid when market returns are low. In this paper, we explore the determinants of liquidity risk, focusing on individual stocks to better understand the mechanisms that drive liquidity risk in the marketplace. More specifically, we investigate the root causes of liquidity risk around earnings announcements following up on Sadka and Sadka (2005) who link liquidity risk and post-earnings announcement drift. Chordia et al. (2007) and Vega (2007) suggest that random noise trader arrival and strategic market maker liquidity provision provide the impetus for drifting prices following earnings announcements.1 We use the Johnson (2007) model as a guide for our empirical investigation. Johnson models liquidity risk as the change in composition of traders (or degree of flux of the trading population) for any particular stock. We employ various measures of investor flux to demonstrate that the compositional rearrangement of investors emanates from earnings surprises. In turn, this investor flux generates abnormal trading volume,
1

Other papers surmise that liquidity per se, contributes to drift. Bernard and Thomas (1989) conclude that drift is related to delayed reaction while Hou and Moskowitz (2005) link delayed reaction to market frictions. Both Bhushan (1994) and Brav and Heaton (2006) find drift is stronger for smaller stocks with higher trading costs. Ng et al. (2007) argue that high transaction costs limit arbitrage opportunities associated with drift. However, Battalio and Mendenhall (2006) contend that transaction costs do not eliminate abnormal profits to post-earnings announcement drift strategies.

providing a link between abnormal trading volume and liquidity risk. We utilize proprietary Nasdaq trading data to measure investor flux across trader categories, dividing trading data between institutional and individual investor groups that roughly correspond to the informed and noise trader conceptions in the literature.2 We find strong support for the linkage between noise trader risk and liquidity risk along these dimensions.3 In addition, we construct investor flux metrics for various institutional trader types using Bushees (2000, 2001) institutional cla ssifications. We measure institutional flux in two dimensions: i) among investing styles (value vs. growth); and ii) among institutional types (transient, dedicated or quasi-indexing). Along these dimensions we find that liquidity risk also relates to the mix of institutional traders in the market for individual stocks. This dimension of liquidity has strong links to predictable stock return patterns like post-earnings announcement drift. 4 Consistent with Johnson (2007), we document that investor flux around earnings releases is significantly related to noise trader risk, unexpected volume, and trade imbalances. Sadka (2006) provides evidence that post-announcement returns represent compensation for the unexpected variation in the ratio of informed and noise traders in the market (De Long et al. (1990))a form of investor flux. In Johnsons model, both expected and unexpected volume contain information about liquidity risk so that liquidity risk increases with volume. In this regard, our empirical results help to clarify empirical
2

This data is also used by Ellis, Michaely and OHara (2000, 2002), Ellis (2006) and Griffin, Harris and Topaloglu (2003, 2006, 2007). 3 Although Chordia et al. (2007) fail to link drift to liquidity risk at the monthly horizon, we explore liquidity risk at daily frequencies. 4 Consistent with the role of price impact, Hasbrouck (2006) examines liquidity risk in prices (ignoring volume effects) and suggests that trading volume, and perhaps volumes accompanying price impact, plays an important role in liquidity risk.

results linking standardized unexplained volume (SUV) to post-announcement drift (Garfinkel and Sokobin (2006)). Also consistent with investor flux as a risk factor, Mendenhall (2004) shows that stocks with high idiosyncratic volatility (or high arbitrage risk) experience greater drift. We demonstrate that each of these conceptual links to risk emanate from the flux in the investor set around earnings announcements. We contribute to the analysis of post-earnings announcement drift by investigating the catalyst of liquidity risk--the flux in the trading population--in postannouncement markets. As Battalio and Mendenhall (2005) show, institutions and individuals trade differently around earnings announcements, benchmarking to analyst forecasts and prior year earnings, respectively. These differential reactions suggest that investor flux occurs as analyst forecasts and seasonal random walk earnings diverge. Indeed, Woodruff and Senchack (1988) find that positive earnings surprises are immediately followed by a large number of small trades and later followed by relatively fewer trades with higher volume, implying that either retail investors enter the market earlier than institutions or, more likely, that institutions are not able to trade large blocks of shares immediately following these announcements. Investor flux can be represented by changes in the ratio of informed to noise traders, the ratio of informed to uninformed traders, or the mix of different institutions holding stock, highlighting the central role of institutional holdings and trading in determining flux. We find that larger institutional holdings serve to magnify investor flux around earnings announcements and thus increase liquidity risk in the market. Following up on Seppis (1992) finding that block price changes are related to quarterly earnings surprises, we find that institutional trading prior to earnings announcements

appears to temper investor flux at the announcement as institutions incorporate value relevant information ahead of earnings news. Likewise, we find that post-announcement trade sizes are negatively related to liquidity risk, consistent with the challenge of trading large quantities of stock without price impact in response to earnings news. Increased liquidity risk is reflected in the excess volatility of post-announcement returns, signifying the trouble that arbitrageurs face in trading at relatively unstable prices in the postannouncement market. Our results help to unify various theories of risk and empirical findings in financial markets. Noise trader risk, liquidity risk and opinion divergence (Bamber (1986, 1987), Kim and Verrecchia (1994), and Garfinkel and Sokobin (2006)) are each hypothesized to affect post-earnings announcement drift. Since investor flux is effected by trades in the public markets, greater investor flux generates greater trading volume. We show that volume proxies for opinion divergence effectively capture the underlying shift in the investor set. In this sense, liquidity risk and opinion divergence can be considered conceptually equivalent both are representations of investor flux, the compositional rearrangement of investors in the stock.

2. Variable Definitions Johnson (2007) models liquidity risk as the second moment of liquidity changes, or liquidity risk, with this liquidity risk representing the degree of flux of the investor set. We develop a number of proxies for the degree of flux through various classification schemes for identifying the different types of investors both trading and holding stock around earnings announcements. Figure 1 shows a timeline depicting the measurement

intervals of our variables. Earnings announcements for quarter q are made between date q and q+1. Numerous models and empirical papers differentiate between institutional (sophisticated) investors and retail investors (perhaps noise traders). To capture the composition of investors in each stock along this dimension, we measure the percent of total trading5 in each stock i traded by institutional investors as i where
TotalInstituionalTradingVolume . TotalVolume

Q represents the difference in before and after earnings announcements, or,

Q
post pre

We also measure the change in institutional holdings in a firm during the quarter prior to the earnings announcement as IH where
IH ( IH q IH q 1 )

where IH is the percent of total outstanding shares held by institutions and q quarter end date of the earnings announcement. IH gives us a measure of the flux of institutional holdings in the period prior to the earnings announcement and can serve as a conditioning variable to assist with interpreting changes to institutional holdings. QIH represents the difference in institutional holdings before and after the earnings announcement as Q IH
( IH q
1

IH q ) .

In the spirit of liquidity risk modeled by Johnson (2007), we examine proxies that more closely capture changes in the willingness to bear risk among investors in the firm.

We estimate institutional trading volume by categorizing each trade via the identity of the brokerage that handles the trade (see Griffin et al. (2003)). Briefly speaking, we identify institutional brokerages via web searches and conversations with firms, brokerages and Nasdaq officials and identify smaller, unknown firms by extrapolating trade-size distributions from known-brokerage distributions.

First, we use institution types (classified by Bushee (2000, 2001) as dedicated, transient, or quasi-indexing institutions) to measure the compositional rearrangement of investors. We use Flux1 to represent the percent of total shares outstanding that turned over across institutional types during the announcement quarter, where
3

Flux1
i 1

| (TypeIH i q

TypeIH i q ) | .

Flux1i is the change in the percent of outstanding shares held by type (i.e., dedicated, transient, and quasi-indexing) institutions (i) for the quarter prior to (q) and quarter following (q+1) the announcement. Using a second Bushee (2000, 2001) classification, by size and investment style, we compile another measure of the compositional rearrangement among investors. We classify institutional investors by size and style as large-value, large-growth, small-value or small-growth institutions. We label the percent of total shares that changed hands across institutional classes during the announcement quarter as Flux2 where
4

Flux 2
i 1

| (ClassIH i q

ClassIH i q ) | .

Flux2i equals the change in the percent of outstanding shares held by class of (i.e., largegrowth, large-value, small-growth and small-value) institutional investors (i) for the quarter prior to (q-1) and quarter following (q) the announcement. A third, overarching proxy for liquidity risk is captured by the change in concentration of institutions holding stock in a firm. Intuitively, when institutional holdings are highly concentrated among few institutions, then there is a risk that institutions will not find another party with which to trade. In addition, concentrated holdings create difficulty in maintaining pre-trade anonymity for larger orders.

Therefore, the change in concentration of institutional holdings also captures dimensions of compositional rearrangement following earnings announcements. We use a Herfindahl index to measure the institutional holding concentration for each firm i in the quarter preceding the earnings announcement. We define our Herfindahl as
N

HerfIH
i 1

IH i 2 ) IH TOT

where IHi is the percent of total shares outstanding held by institution i, IHTOT is the total percent of outstanding shares held by institutions, and N represents the number of institutions holding stock in firm i, each measured in the quarter prior to the earnings announcement. We define HerfIH as the change in the Herfindahl index prior to the earnings announcement, i.e., HerfIH =(HerfIHq-11 HerfIHq), to as a benchmark that exists prior to the earnings announcement. The change in institutional holdings concentration around the earnings announcement represents a third measure of liquidity risk. We define QHerfIH as the difference between the Herfindahl index of institutional holdings measured the quarter before (q) and the quarter after (q+1) the earnings announcement, or
Q HerfIH ( HerfIH q
1

HerfIH q ) .

As Johnson (2007) argues, liquidity risk measured by the flux of the composition of the investors can operate through changing risk preferences of those investors. Therefore, we use the style characteristics provided in Bushee (2000, 2001) to construct our fourth liquidity risk proxy. Style characteristics (large-growth, small-value, etc.) isolate risk preferences of institutional investors. Changing institutional holdings along these style dimensions, therefore, represent changes to the risk preferences of the investor set, and thus capture liquidity risk. Increased holdings by growth firms, for instance, 7

represents a change to higher risk tolerance among institutional holders. For this proxy, we first calculate changes to growth and value firm holdings separately from the quarter prior (q) to the quarter following (q+1) the earnings announcement. Our liquidity risk proxy, QRisk, is then defined as the absolute value of the difference between changes in institutional holdings of growth firms and value firms, or
Q Risk | ( IHGrowthq
1, q

IHValueq

1, q

)|

where IHGrowthq+1,q and IHValueq+1,q are the changes in institutional holdings of growth and value firms, respectively, from the quarter prior to the earnings announcement (q) to the quarter following the announcement (q+1).

3. Data We collect and verify all quarterly earnings announcements for Nasdaq-traded firms announced during 2003 through 2005 from the Factiva data set. We use Nasdaqtraded firms in our sample since the primary data source for our analysis consists of proprietary trade data obtained directly from Nasdaqs transaction confirmation service. The Nasdaq Stock Market uses this facility to aid in the settlement process and for trade reporting to the Consolidated Tape. In this regard, the integrity of the data appears to be strong. The data include the date, time, ticker symbol, trade size and price of each transaction. In addition, these proprietary data also identify the market makers involved on the buy and sell sides and whether the trade was executed for a client or for the market makers proprietary account.6

For trades executed via Electronic Communications Networks (ECNs), two records typically appear in the dataone record indicating a seller with the ECN as counterparty and a second record (not reported to the Consolidated Tape) indicating a buyer with the same ECN as counterparty. We process the data to match

We classify each market participant in the data as trading on behalf of institutions, individuals or handling mixed customer order flow (extending and updating the classification scheme described in Griffin et al. (2003) to include changes to the market participant set). We also collect quarterly institutional holdings data from Spectrum data, taking great care to rectify widely-known issues with the accuracy of this data. We supplement this institutional holdings data with institutional classification data obtained directly from Brian Bushee. The Bushee data classifies Spectrum institutions by type (as quasi-indexers, dedicated or transient institutions), and also by investment style (as small, large, value or growth). We collect accounting data for each of our sample firms from the Compustat database. We use the Center for Research of Securities Prices (CRSP) database for prices, returns, individual firm trading volume, and Nasdaq market returns. Market trading volume is collected directly from Nasdaq systems. 3.1 Sample Descriptive Statistics Table 1 shows the descriptive statistics for our sample. Our sample consists of 11,094 quarterly earnings announcements which occurred during 2003 through 2005 for Nasdaq-listed firms. We divide the sample into positive earnings news and negative earnings news based on the difference between IBES actual earnings and IBES forecasted earnings. As Table 1 shows, our 11,094 observations are split between 7,041 positive surprises and 4,053 negative surprises. Panel A shows firm characteristics for the entire sample as well as for the positive and negative surprise sub-samples. Average daily trading volume (ADV) for all firms in
the two market makers in these trades. Reported trades comprise the basis for the New York Stock Exchanges Trade and Quote (TAQ) data, for instance.

the quarter prior to the earnings announcement averages 1,073.2 thousand shares. However, trading volume is skewed as the median ADV is 233.31 thousand shares. Earnings per share (EPS) average $0.26 per share with a median of $0.22 per share. EPS is significantly higher for firms with positive surprises than negative surprises ($0.33 vs. $0.13). Size is measured as total assets as well as market capitalization. Average total assets for the sample firms are $2,031.46 million while the average market capitalization is $2,523.07 million. However firm size is also skewed as the median assets are $479 million and the median market capitalization is $588.75 million. Both the measurements of firm size show that firms with positive surprises are much larger than firms with negative surprises (p-values of 0.000). We measure volatility as the standard deviation of daily returns for one quarter prior to the earnings announcement. Firms with negative surprises have significantly (p-value=0.000) higher volatility than firms with positive surprises (2.41% and 2.23%, respectively). Panel B shows institutional ownership characteristics for the sample. The sample is divided into two sub-samples based on the level of institutional holdings. The average firm is held by just over 122 institutions (median is 97 institutions). The average firm in the high institutional holdings sub-sample is held by about 136 institutions (median of 108) while the average firm with low institutional holdings is held by about 97 institutions (median of 80). Institutional holdings are a significant portion of the investor base, even for these Nasdaq-listed firms. Overall, institutions hold an average 61.86% of the outstanding stock of the sample firms (median of 65.12%). To better understand the composition of the institutional holdings base, we use Bushee (2000, 2001) classifications of institutional investors by three different types:

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dedicated, transient, and quasi-indexer.7 Dedicated institutions hold just 3.61% of outstanding shares. Transient institutions comprise the majority of institutional holdings with an average of 36.13% of outstanding shares. Quasi-indexing institutions hold another 17.72% of outstanding shares. Notably, dedicated institutions hold significantly more shares in firms experiencing negative surprises than positive surprises. The opposite is true for transient and quasi-indexing institutions, which hold significantly more shares in firms that experience positive surprises. Although institutions hold about 60% of outstanding shares, institutional trading ( ) prior to the earnings announcement averages just 43.66% of total trading volume. In Table 2, we show changes to the various sample characteristics. We focus on changes to these characteristics to highlight the degree of flux of the investor set around earnings announcements. Given that the significant institutional presence is dominated by quasi-indexers and transient institutions, we anticipate that the degree of flux may be substantial for these Nasdaq firms. To get a feel for the interaction between the size of the earnings surprise and changes to these characteristics, we show changes across IBES surprise deciles, with decile one representing the largest negative earnings surprises and decile ten representing the largest positive surprises. We define the IBES surprise as the actual earnings per share minus IBES forecast scaled by the forecast.8 The first row in Table 2 provides the actual surprises, which range from -3.137% for negative surprises to 1.470% for the most positive surprises. The second row demonstrates that SUV, the measure of unexplained volume at the earnings announcement, is significant across all surprise deciles, and reflects the greatest volume
7 8

The authors are grateful to Brian Bushee for providing his institutional investor classfications. Results using prediction errors (the two-day cumulative abnormal return around the announcement) as the surprise are qualitatively similar.

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response to the most positive surprises. Notably, the volume response to the most negative surprises, although significantly inflated, is lower than all other surprise deciles. Q represents the change in institutional trading levels () from the quarter before through the quarter after the earnings announcement (excluding the announcement period). For firms with the largest positive surprises (deciles 7 through 10), the ratio of institutional trading to total trading falls significantly, signaling the fact that relatively more noise traders and fewer institutions trade after a positive earnings surprise. Institutional holdings, however, increase significantly after earnings announcements in every surprise decile so that institutions that do trade are buying shares. The smallest increases occur in deciles 3 through 7, highlighting that the larger increases occur for firms with the biggest surprises. Using Bushees (2000, 2001) classifications of institutional trader types, we track quarterly changes in institutional holdings from the quarter prior to the quarter following the announcement by type as dedicated, transient, and quasi-indexers (labeled QDedicated, QTransient, and QQIX, respectively). Dedicated institutional holdings increase significantly (for all but decile 7), but by only a small increment from before to after the earnings announcement. Changes to transient holding are larger in each decile and increasing in the absolute value of surpriselarger surprises generate greater increases to transient institutional holdings. Transient institutions appear to be attracted to earnings surprises, consistent with active managers pursuing short-term profit opportunities in these stocks. Quasi-indexing institutions change holdings the most across all surprise deciles, with the largest increase occurring for firms with the most positive surprises.

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We measure the flux of institutional holding changes in two different ways. Flux1 captures the degree of rearrangement in the investor set across the dedicated, transient and quasi-indexing types. The lowest flux occurs for deciles 3 through 7, with the most total shares changing hands following the largest positive surprises (deciles 9 and 10, with 7.232% and 8.180% of total outstanding shares changing hands, respectively). Similarly, Flux2 captures the degree of rearrangement in the investors set across classes of institutions measured by combined size and value/growth metrics. Similar to Flux1, the lowest flux occurs for deciles 3 through 6, with the most total shares changing hands following the largest positive surprises (deciles 9 and 10, with 11.053% and 12.411% of total outstanding shares changing hands, respectively). Given the flux in institutional holdings around earnings announcements, we measure the concentration of institutional ownership with a Herfindahl index. We expect that an increase in concentration might lead to greater liquidity risk as institutions may find fewer counterparties with which to trade. However, Table 2 shows that generally, institutional ownership concentration changes little following earnings announcements and the largest surprises result in a decrease in institutional concentration. However, the change in the risk preferences of the institutional investors ( QRisk) increases in the absolute value of the surprise. Growth funds are attracted to firms that experience larger earnings surprises, with the greatest change in risk profile occurring in the top two positive surprise deciles. To explore the drivers of abnormal volume (SUV) around earnings announcements, Table 3 presents the same variables as Table 2 across SUV deciles. We place firms with the highest level of unexplained trading volume in decile 10 and firms

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with the lowest level in decile 1. Note that the average level of surprise is never positive across SUV deciles. When unexplained volume is highest, the change in institutional trading (Q) is the most negative, suggesting that unexplained volume is driven by retail investors. However, institutions are net buyers around earnings announcements-institutional holdings increase across all levels of unexplained volume, with the greatest increase when unexplained volume is highest. All types of institutions increase their holdings following the earnings announcement, but quasi-indexers and transient institutions increase their holdings by a much greater percentage than the dedicated institutions. Generally, transient and quasiindexing institutions increase their post-earnings announcement holdings as SUV increases, although these patterns are not strong. Across all SUV deciles, investor flux increases significantly. Higher unexpected volume is accompanied by greater flux in general. Flux1, capturing the rearrangement by dedicated, transient and quasi-indexing institutions, increases monotonically over deciles 2 through 10. Flux2, capturing rearrangement over size and value/growth dimensions, also increases with SUV, although not monotonically. Unexpected volume appears to be related to the degree of flux around earnings announcements. The concentration of ownership among institutions (the Herfindahl index) does not significantly change surrounding the earnings announcement. The risk profile changes (QRiskIH) are positive and increasing across the SUV deciles, suggesting that when value and growth institutions react most differently, unexpected volume is greatest. 4. Regression Results

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The results in Tables 2 and 3 suggest that investor composition changes around earnings announcements are related to both earnings surprises and unexpected volume at the announcement. The dynamic nature of trading and holdings in conjunction with earnings surprises, however, suggests that multivariate regressions are required to make statements about the marginal impact of each parameter independently. In Table 4, we first examine how investor composition and unexplained volume affect the change in institutional investor risk preferences surrounding earnings announcements. Perhaps intuitively, institutional holdings in the quarter prior to the earnings announcement are positively related to changing institutional risk preferences. Controlling for the prior level of institutional holdings, the change in institutional holdings is significantly positively related to the change in risk as well. Likewise, abnormal volume (SUV) is positively related to the change in risk. Conversely, higher institutional trading prior to the announcement () is associated with a smaller change in institutional risk preferences following the announcement suggesting that preannouncement institutional trading may reveal anticipated risk changes. Firm size (market capitalization) is negatively related to risk changes, indicating that smaller firms experience larger changes in risk, ceteris paribus. Although smaller firms generally trade less frequently, conditional on firm size, trading volume is positively related to risk changes, highlighting the marginal impact of volume on risk. Growth prospects (as measured by market-to-book) have no relation to the changes in risk around earnings announcements. Earnings announcements not only change the risk preferences of institutional investors, but also the risk associated with the stock itself. Liquidity risk arises around

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earnings announcements resulting from the changing composition of investors trading the stock. Institutions wishing to profit from trades surrounding earnings announcements face this liquidity risk in part due noise trader riskthe uncertainty of noise traders entering or exiting the market. Institutions face the risk that they will not be able to find a party with whom to trade if there are not enough noise traders in the market. In this regard, when and if noise traders enter the market are sources of liquidity risk for institutions. Collectively, we refer to this liquidity risk caused by small or retail traders as noise trader risk. We use three measures of noise trader risk. The first is standardized unexplained trade size (SUT) which proxies for the degree to which institutions have to break up orders into smaller trade sizes. Smaller trade sizes indicate that other institutional counterparties could not be found and therefore proxy for the risk of trading directly with retail investors. Our second noise trader risk proxy is the difference between postannouncement stock price volatility relative to pre-announcement volatility. This measure proxies for noise trader risk in the sense that institutional orders that find it hard to locate counterparties will have greater temporary price impact, resulting in greater measured price volatility. Our third measure of noise trader risk is the change in the ratio of post-announcement institutional trading volume to total trading volume relative to the pre-announcement ratio (Q). Intuitively, this measure captures the changing composition of traders in the market and the degree to which retail (noise) traders enter or exit the market around earnings announcements. In columns 1 and 2 of Table 5, we show that, controlling for the level of institutional holdings or holdings by institutional type prior to the earnings announcement

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(which are each insignificant), there is a significantly negative relation between unexplained volume and unexplained trade size. When unexplained volume is higher, unexplained trade size is smaller, suggesting that the presence of a large number of retail traders (who trade in smaller sizes) is related to greater volume at the announcement. Notably, firms with the more positive surprises also experience smaller unexplained trade sizes surrounding the earnings announcement. Institutions wishing to trade firms with positive earnings news face the greater risk that noise traders attracted to the good news firms may force the institutions to break up orders into smaller trades. Columns 3 and 4 in Table 5 show the relation between institutional holdings and unexplained volume with the change in stock price volatility surrounding the earnings announcement. There is a strong positive relation between prior quarter institutional holdings (largely driven by the holdings of quasi-indexers) and noise trader risk. Unexplained trading volume (SUV) is positively related to the change in stock price volatility surrounding the earnings announcement. When unexplained volume surrounding the earnings announcement increases, noise trader risk following the announcement increases. There is also a positive relation between earnings surprises and the change in volatility following the earnings announcement. Lastly, columns 5 and 6 in Table 5 show results when noise trader risk is measured as the change in the ratio of institutional trading volume to total trading volume surrounding the earnings announcement (Q). Prior quarter institutional holdings are negatively related to this measure of noise trader risk, so that higher levels of institutional holdings prior to announcements lead to smaller changes in the composition of investors

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trading surrounding the earnings announcement, driven primarily by the holdings of quasi-indexers. We find a significantly negative relation between unexplained volume and the change in investor composition after the earnings announcement. It appears that retail investors entering the market after the earnings announcement increase the liquidity risk faced by institutions. Institutions may not be able to find traders willing to trade with them at the time and price at which they want to trade. Institutional holdings appear to affect two of our three noise trader proxies. Our univariate results also indicated that institutions (of all types) increase their holdings following earnings announcements. Therefore, we expect that some of the increase in unexplained volume (SUV) results in institutions holding more shares after the earnings announcement due to their trading at the earnings announcement. In Table 6 column 1, we show that both pre-announcement institutional holdings and trading are significantly positively related to the change in institutional holdings surrounding the earnings announcement. Furthermore, we show that unexplained volume is, in fact, significantly positively related to the change in institutional holdings surrounding the earnings announcement. Larger positive surprises lead to greater increases in institutional holdings as well. Notably, lower levels of institutional trading prior to the announcement () are associated with greater changes to institutional holdings. Smaller firms, firms with greater market-to-book ratios and firms with larger trading volumes prior to the announcement also experience greater changes to institutional holdings following the announcement.

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Columns 2 through 4 in Table 6 present parallel analyses by institutional investor type. We find that prior holdings by dedicated institutions are negatively related to changes in dedicated holdings whereas prior holdings by transient institutions are positively related to changes in transient holdings. Among each group, we find that changes to holdings prior to announcements are positively related to changes following announcements, particularly for quasi-indexing institutions. For changes among dedicated and transient institutions, we find a positive relation between unexplained volume and the change in holdings of each type. However, there is no significant relation between unexplained volume and changes in quasi-indexer holdings. Based upon their definition, we expect that transient investors trade heavily surrounding earnings announcements with the result that unexplained volume increases. Greater positive earnings surprises are associated with significantly smaller changes in dedicated institutional holdings. Dedicated institutions appear to change holdings more when earnings surprises are more negative, for even dedicated institutions can lose faith with ever larger negative surprises. Conversely, greater positive surprises generate greater changes in both transient and quasi-indexing institutions. The change to quasi-indexer holdings might be expected if they add firms that have positive returns and sell firms with negative returns (as their moniker suggests).9 The increase in transient institutional holdings with more positive surprises suggests that transient investors are attracted to firms with good news. Greater pre-announcement institutional trading () is related to greater changes in dedicated institutional holdings, but related to smaller changes in both transient and quasi-indexer holdings. Holdings of each institutional type change less for larger firms
9

This finding serves to validate the Bushee (2000, 2001) categorization as well.

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but change more for high market-to-book firms. In addition, holdings of each institutional type increase with trading activity, reflecting the fact that more liquid firms offer greater opportunities to change positions. To further explore the changing nature of the market in response to earnings announcements, Table 7 presents an analysis of standardized order imbalances that occur both at the earnings announcement and during the three month following the announcement. As shown, earnings surprises are strongly significantly related to both announcement and post-announcement buy imbalances. The interaction between surprise and unexpected volume is negatively related to buy imbalances, suggesting that greater volume at the announcement serves to reduce imbalances both at the announcement as well as into the following three months. Similarly, the interaction between surprise and institutional holdings is also negatively related to buy imbalances, driven particularly by quasi-indexing institutional holdings. These results suggest that quasi-indexer holdings and greater trading volume at the announcement mitigate liquidity risk and are signs that relatively more adequate liquidity exists to clear orders in these firms when earnings surprises occur. Table 7 also indicates that larger firms experiencing more positive surprises experience larger buy imbalances, as might be expected. However, higher book-tomarket firms experiencing more positive surprises experience fewer imbalances. Similarly, more frequently traded firms experiencing more positive surprises also experience fewer imbalances, perhaps suggesting that greater trading activity indicates more liquidity in the market. Firms with greater momentum and greater volatility experiencing more positive surprises also experience fewer imbalances, perhaps

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suggesting that prior volatility and momentum serve to dissipate buying demand in advance of earnings announcements. 4. Post-earnings Announcement Drift Analysis Tables 4 through 7 serve to demonstrate the dynamic nature of market behavior surrounding earnings announcements, particularly when the announcement represents a surprise to the investing community. Changes to institutional risk profiles, noise trader risk, changes to both dedicated and transient institutional holdings, and buy order imbalances are each significantly related to unexpected volume at the earnings announcement (SUV). Johnson (2007) provides a theoretical link between liquidity risk and volume. Garfinkel and Sokobin (2006) assert that SUV is a measure of opinion divergence among investors that is related to post-earnings announcement drift. In Table 8, we examine determinants of SUV directly to better understand how and why SUV might affect drift. As shown in Table 8, column 1, SUV is significantly positively related to the dispersion of analyst forecasts prior to the announcement, suggesting that each may proxy for opinion divergence. We also find that the level of institutional holdings prior to the earnings announcement is positively related to SUV, a result largely anticipated since abnormal trading volume likely depends on institutional trading. Notably, columns 2 and 3 show that quasi-indexer holdings largely drive unexpected volume at the announcement, with transient institutional holdings playing a marginal role. 10 As expected from the Garfinkel and Sokobin (2005) analysis, SUV is also positively related to positive earnings surprises.

10

Ke and Ramalingegowda (2005) find that transient institutions exploit post-announcement drift for NYSE/AMEX firms and earn abnormal profits.

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We anticipate that greater institutional holdings changes prior to announcements may lead to greater unexpected volume at the announcement if prior changes are a sign of institutional activity. However, we find that SUV is negatively related to prior institutional changes, perhaps suggesting that prior changes indicate institutional trading in advance of the announcement. Along these lines, we also anticipate that the more trading institutions do prior to the earnings announcement, the lower SUV will be since institutions trading in anticipation of announcements are likely to trade less once the news is released. We find this in fact to be true. Large market-to-book firms experience greater unexpected volume at earnings announcement. Conversely, high volatility firms are associated with lower SUV, suggesting that volatility prior to the announcement indicates an impediment to trading effectively when earnings are released. Along these same lines, firms experiencing relatively higher trading volume prior to the announcement also experience larger unexpected volume at the announcement. This result is also consistent with the conjecture that higher trading volume indicates the efficacy of executing orders when earnings are released. These results suggest that the determinants of SUV are related to liquidity risk in the market at the time of the earnings announcement. Greater institutional holdings (especially transient institutions which are more likely to trade) and greater retail trading (the reciprocal of institutional trading, ) both lead to greater SUV, consistent with noise trader risk affecting trading volume at the announcement. Likewise, more volatile and less actively traded firms experience lower SUV, consistent with firm characteristics that inhibit trading in response to the announcement.

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To explore whether these firm characteristics proxy for liquidity levels or for liquidity risk, we add a control variable for the liquidity level in column 3. Spreadpf is the portfolio rank of the relative spread over the three months prior to the earnings announcement and therefore proxies for the liquidity level. Indeed, we find that firms with greater spreads prior to the announcement experience lower trading volume at the announcement, consistent with SUV depending on liquidity levels. The restriction on liquidity prior to the earnings announcement leads to more trading at the earnings announcement since institutions intending to trade in advance of earnings that face liquidity constraints are forced to wait until noise traders enter the market at the announcement. The uncertainty associated with noise trader arrival represents a form of liquidity risk in the market. Notably, adding the spread proxy for liquidity levels fails to affect the significance of the other variables that we deem proxies for liquidity risk. Unexplained volume at the announcement (SUV) is driven by a number of firm and market conditions. We believe that our analysis of these determinants show that SUV is a product of both liquidity levels and liquidity risk. To the extent that SUV represents opinion divergence, our results suggest that opinion divergence is largely a manifestation of liquidity characteristics. More liquid, actively-traded, low volatility stocks experience greater abnormal volume at the earnings announcement. Similarly, stocks with greater transient institutional holdings and greater retail trading also experience greater abnormal volume at the announcement, suggesting that potential flux in the underlying investor base, or liquidity risk, affects SUV as well. To close the loop on our analysis, we explore three-month post-earnings announcement drift in Table 9. In the first column we replicate Garfinkel and Sokobins

23

(2006) results linking standardized unexplained volume (SUV) to drift over the subsequent three months. SUV is positively related to post-earnings announcement drift. This relation almost completely subsumes the addition of prior quarter institutional holdings and prior quarter change in institutional holdings to the regression as well (perhaps not surprisingly since the SUV measure is an amalgamation of a number of both holdings and changes to holdings, among other variables as shown in Table 8). We do find that the change in institutional holdings prior to the announcement is weakly related to driftthe more institutions increase holdings prior to the announcement (and reduce exposure to noise trader risk), the less drift occurs following earnings surprises. 5. Conclusions We study 11,094 quarterly earnings announcements of firms traded on the Nasdaq Stock Market and find that higher liquidity risk leads to greater post-earnings announcement drift in the three months following earnings announcements. Prior literature documents a negative relation between liquidity levels and post-announcement drift. Delayed investor reactions have also been tied to post-earnings announcement drift, although the duration and persistence of drift has presented a challenge to empirical researchers. Garfinkel and Sokobin (2006) document a positive relationship between standardized unexplained volume (SUV) at the time of the earnings announcement and the post-earnings announcement drift, surmising that SUV proxies for opinion divergence. We examine the determinants of SUV and argue that both liquidity and liquidity risk contribute significantly to SUV at the earnings announcement. These results suggest that SUV, and opinion divergence more generally, can be considered

24

manifestations of liquidity levels and liquidity risk that, in turn, affects post-earnings announcement drift. Our results also provide support for Johnsons (2007) model where the changing composition of investors in a firm, or investor flux, represents liquidity risk. We find that investor flux--whether measured by the mix of individual and institutional holdings, by Bushees (2000, 2001) transient, dedicated and quasi-indexing institutional type, or by his size and value/growth combinationsis greater when earnings surprises are larger. We find that investor flux has a number of empirical footprints in our data. Noise trader risk proxies (volatility and the relative degree of individual investor participation) are significantly related to the composition of the investor set prior to the announcement. Furthermore, flux is significantly related to the abnormal volume at the earnings announcement and post-announcement trade imbalances. Institutions wishing to take positions to capitalize on predictable drift following an earnings announcement face the risk of uncertain counterparties to their trade. Facing an uncertain set of retail traders (or noise trade risk), institutions are unable to profitably trade against predictable post-announcement drift patterns. Our results suggest that threemonth post-earnings announcement drift represents not a violation of efficient markets, but rather appropriate compensation for liquidity risk in the market for individual stocks.

25

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DeLong, J.B., A. Schleifer, L.H. Summers and R.J. Waldmann, 1990, Noise Trader Risk in Financial Markets, The Journal of Political Economy, 98, 4, 703-738. Ellis, K., 2006, Who trades IPOs? A Close Look at the First Days of Trading, Journal of Financial Economics 79, 339-363. Ellis, K., R. Michaely and M. OHara, 2000, When the Underwriter is the Market Maker: An Examination of Trading in the IPO Aftermarket, Journal of Finance 55, 1039-1074. Ellis, K., R. Michaely and M. OHara, 2002, The Making of a Dealer Market: From Entry to Equilibrium in the Trading of Nasdaq Stocks, Journal of Finance 57, 2289-2316. Fama, E.F., 1998, Market Efficiency, Long-run Returns, and Behavioral Finance, Journal of Financial Economics 49, 3, 283-307. Goetzmann, W. N. and M. Massa, 2005, Dispersion of Opinion and Stock Returns, Journal of Financial Markets 8, 325-350. Garfinkel, J. and J. Sokobin, 2006, Volume, Opinion Divergence, and Returns: A Study of Post-Earnings Announcement Drift, Journal of Accounting Research 44, 85-112. Griffin, J. M., J. H. Harris and S. Topaloglu, 2003, The Dynamics of Institutional and Individual Trading, Journal of Finance 58, 2285-2320. Griffin, J. M., J. H. Harris and S. Topaloglu, 2007, Why are Investors Net Buyers through Lead Underwriters?, Journal of Financial Economics 85, 518-551. Griffin, J. M., J. H. Harris and S. Topaloglu, 2006, Who Drove and Burst the Tech Bubble?, University of Delaware working paper. Hasbrouck, J., 2006, Trading Costs and Returns for US Equities: Estimating Effective Costs from Daily Data, New York University working paper. Hou and Moskowitz, 2005, Market Frictions, Price Delay, and the Cross-Section of Expected Returns, Review of Financial Studies 18, 3, 981-1020. Johnson, T., 2007, Volume, Liquidity, and Liquidity Risk, forthcoming Journal of Financial Economics. Ke, B. and S. Ramalingegowda, 2005, Do Institutional Investors Exploit the Postearnings Announcement Drift, Journal of Accounting and Economics 39, 25-53. Kim, O. and R. E. Verrecchia, 1994, Market Liquidity and Volume around Earnings Announcements, Journal of Accounting and Economics 17, 41-67.

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Mendenhall, R.R., 2004, Arbitrage Risk and Post-earnings Announcement Drift, The Journal of Business 77, 4, 875-895. Pastor, L. and R.F. Stambaugh, 2003, Liquidity Risk and Expected Stock Returns, The Journal of Political Economy 111, 3, 642-706. Sadka, R., 2006, Momentum and Post-earnings Announcement Drift Anomalies: The Role of Liquidity Risk, Journal of Financial Economics 80, 309-333. Sadka, G. and R. Sadka, 2005, The Post-Earnings-Announcement Drift and Liquidity Risk, University of Chicago Working Paper. Sadka, R. and A. Scherbina, 2007, Analyst Disagreement, Mispricing and Liquidity, Journal of Finance, forthcoming.

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Figure 1 Timeline of Variables

Quarter End Quarter End Quarterly Earnings Quarter End Date Date Announcement Date (q-1) (q) (q+1) __________|________________________ |_______________________|_________________________|__________ | | | SUV IH Dedicated QIX Transient HerfIH HerfIH Q IH QIH Dedicated QDedicated QIX QQIX Transient QTransient QFlux1 QFlux2 QHerfIH QRiskIH

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Table 1 Descriptive Statistics by Surprise Types

The table compares means (medians) of the earnings announcement sample based on surprise type. The statistics are based on a sample of 11,094 quarterly earnings announcements of Nasdaq-listed firms from 2003 through 2005. A surprise is positive if the actual earnings exceed the IBES forecasted earnings and negative otherwise. Average Daily Volume, in thousands, is the average daily trading volume of the firm over the quarter prior to the earnings announcement. Earnings per share exclude extraordinary items. Momentum is the size-adjusted cumulative abnormal return in the quarter prior to the earnings announcement. Market-to-book is the market capitalization of the firm at the end of the prior quarter scaled by total assets at the end of the prior quarter. Market Capitalization, in millions, is total shares outstanding at the end of the prior quarter multiplied by the end-of-prior quarter price. Total Shares outstanding, in millions, is the number of common shares outstanding at the end of the prior quarter to the earnings announcement. Total assets are shown in millions as reported in the quarter immediately prior to the announcement. Volatility is the standard deviation of daily returns over the quarter prior to the earnings announcement ending on day T-5. NumInst is the number of institutions holding stock in a firm. HerfIH is the sum of the squared share of each institutions holdings of a firm. An institutions share is defined as number of shares outstanding held by the institution divided by total number of shares held by institutions. is institutional trading divided by total trading volume in the quarter prior to the earnings announcement. IH is the percent of outstanding shares held by institutions at the end of the quarter prior to the earnings announcement. Dedicated is the percent of outstanding shares held by dedicated institutions. QIX is the percent of outstanding shares held by quasi-indexing institutions. Transient is the percent of outstanding shares held by transient institutions. P-values are derived from a t-test that the means are equal based on the sign of the surprise. Panel A: Firm Characteristics Average Daily Volume (000s) EPS Momentum Market-to-book Market Capitalization (millions $) Total Shares Outstanding (millions) Total Assets (millions $) Volatility N Panel B: Institutional Ownership Characteristics NumInst HerfIH IH Dedicated QIX Transient N All 1,073.42 (233.31) 0.26 (0.22) 0.07% (-0.81%) 1.90 (1.43) 2,523.07 (588.75) 99.42 (30.11) 2,031.46 (479.00) 2.29% (2.07%) 11,094 Positive Surprise 1,251.26 (265.01) 0.33 (0.27) 1.76% (0.59%) 2.15 (1.69) 3,084.42 (694.64) 115.85 (31.80) 2,204.35 (514.24) 2.23% (2.04%) 7,041 Negative Surprise 764.46 (194.61) 0.13 (0.13) -2.86% (-3.52%) 1.47 (1.13) 1,547.89 (417.92) 70.87 (28.29) 1,731.09 (413.21) 2.41% (2.15%) 4,053 P-Value 0.00 (0.00) 0.00 (0.00) 0.00 (0.00) 0.00 (0.00) 0.00 (0.00) 0.00 (0.00) 0.00 (0.00) 0.00 (0.00)

122.16 (97.00) 7.07% (5.25%) 43.66% (43.94%) 61.86% (65.12%) 3.61% (0.01%) 36.13% (35.43%) 17.72% (15.44%) 11,094

136.48 (108.00) 6.41% (4.79%) 43.66% (43.88%) 63.59% (67.27%) 3.57% (0.02%) 36.81% (36.25%) 18.86% (16.92%) 7,041

97.27 (80.00) 8.22% (6.20%) 43.66% (43.98%) 58.85% (61.15%) 3.69% (0.00%) 34.96% (34.04%) 15.73% (12.98%) 4,053

0.00 (0.00) 0.00 (0.00) 0.28 (0.37) 0.00 (0.00) 0.01 (0.00) 0.00 (0.00) 0.00 (0.00)

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Table 2 Descriptive Statistics by IBES Surprise Decile

The table compares means of the earnings announcement sample by the level of IBES surprise. The statistics are based on a sample of 11,094 quarterly earnings announcements of Nasdaq-listed firms from 2003 through 2005. The highest positive surprises are in decile 10 while the most negative surprises are in decile 1. IBES is the level of surprise at the earnings announcement calculated as actual earnings per share less IBES forecasted earnings per share scaled by forecast. SUV is a regression-based measure of unexplained volume surrounding the earnings announcement using standard market-based methodology. is institutional trading divided by total trading volume in the quarter prior to the earnings announcement. Q is the difference in post-earnings announcement and pre-earnings announcement. QIH is the difference in institutional holdings post-earnings announcement and pre-earnings announcement. QDedicated is the difference in dedicated institutional holdings post-earnings announcement and pre-earnings announcement. QTransient is the difference in transient institutional holdings postearnings announcement and pre-earnings announcement. QQIX is the difference in quasi-indexing institutional holdings post-earnings announcement and pre-earnings announcement. TypeIH is the absolute value of the sum of the changes in holdings for each institutional investor type. Flux1 is the difference in TypeIH post-earnings announcement and pre-earnings announcement. ClassIH is the absolute value of the sum of the changes in holdings for each institutional investor style. Flux2 is the difference in ClassIH post-earnings announcement and pre-earnings announcement. HerfIH is the sum of the squared share of each institutions holdings of a firm. An institutions share is defined as number of shares outstanding held by the institution divided by total number of shares held by institutions. QHerfH is the difference in HerfIH postearnings announcement and pre-earnings announcement. RiskIH is the difference in institutional holdings of value stocks and growth stocks. QRiskIH is the difference in RiskIH post-earnings announcement and pre-earnings announcement. UVolatility is the change in the standard deviation of returns in the quarter following the earnings announcement from the quarter prior to the earnings announcement. Means in bold are significantly different from 0 at the 5% level. The F-Test p-value results from testing the quality of the means across all deciles.
IBES SUV Q QIH QDedicated QTransient QQIX QFlux1 QFlux2 QHerfIH QRiskIH N 1 -3.137% 1.014 -0.021% 5.286% 0.283% 2.008% 2.293% 6.199% 9.294% 0.261% 3.695% 1,099 2 -0.375% 1.315 0.273% 5.738% 0.219% 2.019% 2.755% 6.506% 9.973% 0.251% 3.787% 1,111 3 -0.121 1.124 0.105% 4.884% 0.235% 1.571% 2.452% 5.727% 8.857% -0.061% 3.301% 1,114 4 -0.030% 1.166 0.072% 4.152% 0.157% 1.177% 2.444% 4.934% 7.789% 0.120% 3.036% 1,027 5 0.003% 1.151 -0.177% 5.082% 0.236% 1.782% 2.338% 5.714% 8.616% 0.063% 3.193% 1,257 6 0.039% 1.293 -0.031% 3.873% 0.089% 1.460% 2.267% 5.074% 7.852% 0.221% 3.054% 1,048 7 0.082% 1.351 -0.224% 5.163% 0.066% 1.811% 2.875% 6.176% 9.564% -0.128% 3.497% 1,112 8 0.151% 1.444 -0.221% 5.647% 0.110% 2.187% 2.776% 6.572% 10.033% 0.031% 3.658% 1,107 9 0.297% 1.514 -0.332% 6.509% 0.131% 2.467% 3.193% 7.232% 11.053% 0.015% 3.870% 1,112 10 1.470% 1.592 -0.347% 7.445% 0.155% 2.975% 3.519% 8.180% 12.411% -0.530% 4.134% 1,107 F-Test P-Value 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000

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Table 3 Descriptive Statistics by SUV Decile

The table compares means of the earnings announcement sample by the level of standardized unexplained volume (SUV). The statistics are based on a sample of 11,094 quarterly earnings announcements of Nasdaq-listed firms from 2003 through 2005. The firms with the highest level of SUV are in decile 10. SUV is a regression-based measure of unexplained volume surrounding the earnings announcement using standard market-based methodology. IBES is the level of surprise at the earnings announcement calculated as actual earnings per share less IBES forecasted earnings per share scaled by forecast. is institutional trading divided by total trading volume in the quarter prior to the earnings announcement. Q is the difference in post-earnings announcement and pre-earnings announcement. QIH is the difference in institutional holdings post-earnings announcement and pre-earnings announcement. QDedicated is the difference in dedicated institutional holdings post-earnings announcement and pre-earnings announcement. QTransient is the difference in transient institutional holdings post-earnings announcement and pre-earnings announcement. QQIX is the difference in quasi-indexing institutional holdings post-earnings announcement and pre-earnings announcement TypeIH is the absolute value of the sum of the changes in holdings for each institutional investor type. Flux1 is the difference in TypeIH postearnings announcement and pre-earnings announcement. ClassIH is the absolute value of the sum of the changes in holdings for each institutional investor style. Flux2 is the difference in ClassIH post-earnings announcement and pre-earnings announcement. HerfIH is the sum of the squared share of each institutions holdings of a firm. An institutions share is defined as number of shares outstanding held by th e institution divided by total number of shares held by institutions. QHerfH is the difference in HerfIH post-earnings announcement and pre-earnings announcement. RiskIH is the difference in institutional holdings of value stocks and growth stocks. QRiskIH is the difference in RiskIH post-earnings announcement and pre-earnings announcement. UVolatility is the change in the standard deviation of returns in the quarter following the earnings announcement from the quarter prior to the earnings announcement. Means in bold are significantly different from 0 at the 5% level. The F-Test p-value results from testing the quality of the means across all deciles.
IBES SUV Q QIH QDedicated QTransient QQIX QFlux1 QFlux2 QHerfIH QRiskIH N 1 -0.268% -1.473 0.066% 4.964% 0.226% 1.698% 2.487% 5.632% 8.660% 0.224% 3.213% 1,103 2 -0.290% -0.429 0.184% 4.690% 0.124% 1.765% 2.421% 5.429% 8.369% 0.048% 3.160% 1,109 3 -0.263% 0.116 -0.074% 4.714% 0.128% 1.751% 2.381% 5.561% 8.493% -0.042% 3.193% 1,114 4 -0.298% 0.549 0.217% 5.161% 0.117% 1.706% 2.780% 5.772% 9.056% 0.211% 3.399% 1,108 5 -0.165% 0.964 -0.038% 5.161% 0.151% 1.891% 2.602% 5.951% 9.092% -0.008% 3.406% 1,109 6 -0.177% 1.381 -0.313% 5.429% 0.110% 1.919% 2.866% 6.465% 9.872% -0.087% 3.467% 1,114 7 -0.087% 1.829 -0.213% 5.721% 0.237% 2.050% 2.810% 6.505% 9.996% -0.095% 3.684% 1,111 8 -0.027% 2.354 -0.209% 6.101% 0.181% 2.216% 3.027% 7.068% 10.816% 0.053% 3.805% 1,111 9 0.026% 3.084 -0.266% 5.804% 0.188% 2.307% 2.659% 6.932% 10.432% -0.062% 3.879% 1,112 10 -0.048% 4.581 -0.277% 6.165% 0.228% 2.203% 2.878% 7.069% 10.735% -0.010% 4.025% 1,103 F-Test P-Value 0.000 0.000 0.000 0.000 0.506 0.000 0.000 0.000 0.000 0.402 0.001

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Table 4 Risk Change Regression The statistics are based on a sample of 11,094 quarterly earnings announcements of Nasdaq-listed firms from 2003 through 2005. QRisk is the change surrounding the earnings announcement of the absolute value of the difference between institutional holdings of value stocks and growth stocks. IHpf is the portfolio rank of the percent of outstanding shares of the firm held by institutions the quarter prior to the earnings announcement. IHpf is the portfolio rank of the change in institutional holdings one quarter prior to the earnings announcement. SUVpf is the portfolio rank of a regression-based measure of unexplained volume using standard market-based methodology. IBESpf is the portfolio rank of the difference between actual earnings and IBES forecasted earnings. pf is the portfolio rank of the ratio of institutional trading to total trading volume in the quarter prior to the earnings announcement. MktCappf is the portfolio rank of the total shares outstanding at the end of the prior quarter multiplied by the end-ofprior quarter price. Mkbookpf is the portfolio rank of the market capitalization of the firm at the end of the prior quarter scaled by total assets at the end of the prior quarter. ADVpf is the portfolio rank of the average daily trading volume of the firm over the quarter prior to the earnings announcement.
QRisk

Intercept IHpf IHpf SUVpf IBESpf pf MktCappf Mkbookpf ADVpf Adjusted R2

1.153 (0.000) 2.563 (0.000) 1.844 (0.000) 0.343 (0.010) 0.266 (0.054) -0.419 (0.001) -2.414 (0.000) 0.234 (0.103) 1.845 (0.000) 0.1097

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Table 5 Noise Trader Regressions The statistics are based on a sample of 11,094 quarterly earnings announcements of Nasdaq-listed firms from 2003 through 2005. SUT is a regression-based measure of unexplained trade size using standard market-based methodology. Uvolatility is the change in the standard deviation of daily returns over one quarter from before the earnings announcement to after the earnings announcement. is the ratio of institutional trading to total trading volume in the quarter prior to the earnings announcement. Q is the difference between post-earnings and pre-earnings . IHpf is the portfolio rank of the percent of outstanding shares of the firm held by institutions the quarter prior to the earnings announcement. Dedicatedpf is the portfolio rank of the percent of outstanding shares of the firm held by dedicated institutions the quarter prior to the earnings announcement. QIXpf is the portfolio rank of the percent of outstanding shares of the firm held by quasi-indexing institutions the quarter prior to the earnings announcement. Transientpf is the portfolio rank of the percent of outstanding shares of the firm held by transient institutions the quarter prior to the earnings announcement. SUVpf is the portfolio rank of a regression-based measure of unexplained volume using standard market-based methodology. IBESpf is the portfolio rank of the difference between actual earnings and IBES forecasted earnings. MktCappf is the portfolio rank of the total shares outstanding at the end of the prior quarter multiplied by the end-ofprior quarter price. Mkbookpf is the portfolio rank of the market capitalization of the firm at the end of the prior quarter scaled by total assets at the end of the prior quarter. ADVpf is the portfolio rank of the average daily trading volume of the firm over the quarter prior to the earnings announcement. Dependent Variable Intercept IHpf Dedicatedpf Transientpf QIXpf SUVpf IBESpf MktCappf Mkbookpf ADVpf Adjusted R2 SUT (1) (2) 0.211 0.197 (0.000) (0.000) 0.019 (0.361) 0.012 (0.566) 0.029 (0.168) 0.015 (0.464) -0.091 -0.092 (0.000) (0.000) -0.144 -0.142 (0.000) (0.000) 0.046 0.045 (0.046) (0.063) 0.038 0.034 (0.060) (0.090) 0.026 0.016 (0.330) (0.560) 0.0081 0.0083 UVolatility (3) (4) -0.247 -0.264 (0.000) (0.000) 0.137 (0.000) 0.058 (0.068) -0.017 (0.611) 0.122 (0.000) 0.214 0.206 (0.000) (0.000) 0.101 0.103 (0.002) (0.002) 0.328 0.307 (0.000) (0.000) -0.030 -0.010 (0.385) (0.783) -0.591 -0.575 (0.000) (0.000) 0.0238 0.0246 Q (5) (6) 0.576 0.679 (0.000) (0.000) -0.697 (0.000) -0.257 (0.053) -0.223 (0.096) -0.525 (0.000) -0.483 -0.438 (0.000) (0.000) -0.505 -0.512 (0.000) (0.000) -0.424 -0.409 (0.004) (0.008) 0.356 0.305 (0.007) (0.022) 0.537 0.633 (0.001) (0.000) 0.0071 0.0074

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Table 6 Changes in Institutional Holdings Regressions The statistics are based on a sample of 11,094 quarterly earnings announcements of Nasdaq-listed firms from 2003 through 2005. QIHpf is the portfolio rank of the change in institutional holdings in the two quarters surrounding the earnings announcement. QDedicatedpf is the portfolio rank of the change in dedicated institutional holdings in the two quarters surrounding the earnings announcement. QTransientpf is the portfolio rank of the change in transient institutional holdings in the two quarters surrounding the earnings announcement. QQIXpf is the portfolio rank of the change in quasi-indexing institutional holdings in the two quarters surrounding the earnings announcement. IHpf is the portfolio rank of the percent of outstanding shares of the firm held by institutions in the quarter prior to the earnings announcement. Dedicatedpf is the portfolio rank of the percent of outstanding shares of the firm held by dedicated institutions the quarter prior to the earnings announcement. Transientpf is the portfolio rank of the percent of outstanding shares of the firm held by transient institutions the quarter prior to the earnings announcement. QIXpf is the portfolio rank of the percent of outstanding shares of the firm held by quasi-indexing institutions the quarter prior to the earnings announcement. IHpf is the portfolio rank of the change in institutional holdings one quarter prior to the earnings announcement. Dedicatedpf is the portfolio rank of the change in dedicated institutional holdings one quarter prior to the earnings announcement. Transientpf is the portfolio rank of the change in transient institutional holdings one quarter prior to the earnings announcement. QIXpf is the portfolio rank of the change in quasi-indexing institutional holdings one quarter prior to the earnings announcement. SUVpf is the portfolio rank of a regression-based measure of unexplained volume using standard market-based methodology. IBESpf is the portfolio rank of the difference between actual earnings and IBES forecasted earnings. pf is the portfolio rank of the ratio of institutional trading to total trading volume in the quarter prior to the earnings announcement. MktCappf is the portfolio rank of the total shares outstanding at the end of the prior quarter multiplied by the end-of-prior quarter price. Mkbookpf is the portfolio rank of the market capitalization of the firm at the end of the prior quarter scaled by total assets at the end of the prior quarter. ADVpf is the portfolio rank of the average daily trading volume of the firm over the quarter prior to the earnings announcement.

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Dependent Variable Intercept IHpf Dedicatedpf Transientpf QIXpf IHpf Dedicatedpf Transientpf QIXpf SUVpf IBESpf pf MktCappf Mkbookpf ADVpf Adjusted R2

QIHpf (1) 0.824 (0.003) 1.330 (0.000)

QDedicatedpf (2) 0.116 (0.119)

QTransientpf (3) 0.076 (0.576)

QQIXpf (4) 0.864 (0.000)

-1.293 (0.000) 0.988 (0.000) -0.019 (0.933) 6.875 (0.000) 0.573 (0.000) 1.702 (0.000) 3.048 (0.000) 0.186 (0.236) 0.901 (0.000) -0.840 (0.000) -2.363 (0.000) 0.975 (0.000) 1.441 (0.000) 0.0793

0.710 (0.014) 1.480 (0.000) -1.402 (0.000) -5.278 (0.000) 1.102 (0.001) 3.485 (0.000) 0.1078

0.114 (0.027) -0.111 (0.025) 0.174 (0.004) -0.160 (0.004) 0.151 (0.016) 0.678 (0.000) 0.0139

0.254 (0.044) 0.959 (0.000) -0.250 (0.051) -2.626 (0.000) 0.399 (0.004) 1.975 (0.000) 0.0737

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Table 7 Buy Imbalance Regressions

The statistics are based on a sample of 11,094 quarterly earnings announcements of Nasdaq-listed firms from 2003 through 2005. SBIPost3m is the standardized cumulative percentage institutional buy imbalances in the three months following the earnings announcement. SBIEA is the standardized cumulative percentage institutional buy imbalances surrounding the earnings announcement. IBESpf is the portfolio rank of the difference between actual earnings and IBES forecasted earnings. SUVpf is the portfolio rank of a regression-based measure of unexplained volume using standard market-based methodology. IHpf is the portfolio rank of the percent of outstanding shares of the firm held by institutions in the quarter prior to the earnings announcement. Dedicatedpf is the portfolio rank of the percent of outstanding shares of the firm held by dedicated institutions the quarter prior to the earnings announcement. Transientpf is the portfolio rank of the percent of outstanding shares of the firm held by transient institutions the quarter prior to the earnings announcement. QIXpf is the portfolio rank of the percent of outstanding shares of the firm held by quasi-indexing institutions the quarter prior to the earnings announcement. MktCappf is the portfolio rank of the total shares outstanding at the end of the prior quarter multiplied by the end-of-prior quarter price. Mkbookpf is the portfolio rank of the market capitalization of the firm at the end of the prior quarter scaled by total assets at the end of the prior quarter. ADVpf is the portfolio rank of the average daily trading volume of the firm over the quarter prior to the earnings announcement. Momentumpf is portfolio rank of the size-adjusted cumulative abnormal return in the quarter prior to the earnings announcement. Volatilitypf is the portfolio rank of the standard deviation of daily returns over the quarter prior to the earnings announcement ending on day T-5. Dependent Variable SBIPost3m SBIEA (1) (2) (3) (4) -35.030 -33.253 -0.445 -0.440 Intercept (0.000) (0.000) (0.000) (0.000) 101.880 100.529 1.673 1.673 IBESpf (0.000) (0.000) (0.000) (0.000) -26.621 -26.411 -0.761 -0.777 IBESpf*SUVpf (0.000) (0.000) (0.000) (0.000) -11.620 -0.209 IBESpf*IHpf (0.010) (0.020) 0.597 -0.028 IBESpf*Dedicatedpf (0.912) (0.798) -5.055 -0.154 IBESpf*Transientpf (0.299) (0.105) -14.875 -0.201 IBESpf*QIXpf (0.003) (0.047) 216.182 211.840 2.182 2.180 IBESpf*MktCappf (0.000) (0.000) (0.000) (0.000) -26.950 -26.868 -0.353 -0.316 IBESpf*Mkbookpf (0.000) (0.000) (0.000) (0.001) -215.657 -208.658 -2.154 -2.091 IBESpf*ADVpf (0.000) (0.000) (0.000) (0.000) -21.054 -19.194 -0.247 -0.238 IBESpf*Momentumpf (0.000) (0.000) (0.007) (0.010) -39.572 -39.388 -0.601 -0.539 IBESpf*Volatilitypf (0.000) (0.000) (0.000) (0.000) Adjusted R2 0.138 0.1382 0.0546 0.0547

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Table 8 Determinants of SUV

The statistics are based on a sample of 11,094 quarterly earnings announcements of Nasdaq-listed firms from 2003 through 2005. SUV is a regression-based measure of unexplained volume using standard market-based methodology. Dispersionpf is the portfolio rank of the standard deviation of analyst forecasts in the month before the earnings announcement. IHpf is the portfolio rank of the percent of outstanding shares of the firm held by institutions the quarter prior to the earnings announcement. Dedicatedpf is the portfolio rank of the percent of outstanding shares of the firm held by dedicated institutions the quarter prior to the earnings announcement. QIXpf is the portfolio rank of the percent of outstanding shares of the firm held by quasi-indexing institutions the quarter prior to the earnings announcement. Transientpf is the portfolio rank of the percent of outstanding shares of the firm held by transient institutions the quarter prior to the earnings announcement. IBESpf is the portfolio rank of the level of IBES surprise. IHpf is the portfolio rank of the change in institutional holdings one quarter prior to the earnings announcement. pf is the portfolio rank of the ratio of institutional trading to total trading volume in the quarter prior to the earnings announcement. MktCappf is the portfolio rank of the total shares outstanding at the end of the prior quarter multiplied by the end-of-prior quarter price. Mkbookpf is the portfolio rank of the market capitalization of the firm at the end of the prior quarter scaled by total assets at the end of the prior quarter. Volatilitypf is the portfolio rank of the standard deviation of daily returns over the quarter prior to the earnings announcement ending on day T-5. ADVpf is the portfolio rank of the average daily trading volume of the firm over the quarter prior to the earnings announcement. Spreadpf is the portfolio rank of the average relative spread over the three months prior to the earnings announcement ending on day T-5. Predicted Sign (1) (2) (3) 0.312 0.232 0.865 Intercept ? (0.000) (0.007) (0.000) 0.188 0.203 0.195 Dispersionpf + (0.002) (0.001) (0.001) 0.410 IHpf + (0.000) 0.077 0.067 Dedicatedpf ? (0.233) (0.300) 0.359 0.283 QIXpf ? (0.000) (0.000) 0.146 0.112 Transientpf ? (0.036) (0.109) 0.292 0.282 0.286 IBESpf + (0.000) (0.000) (0.000) -0.165 -0.169 -0.187 IHpf + (0.010) (0.011) (0.005) -0.228 -0.239 -0.243 pf (0.000) (0.000) (0.000) -0.149 -0.148 -0.456 MktCappf ? (0.108) (0.117) (0.000) 0.759 0.764 0.754 Mkbookpf ? (0.000) (0.000) (0.000) -0.414 -0.387 -0.300 Volatilitypf (0.000) (0.000) (0.000) 1.097 1.055 0.853 ADVpf + (0.000) (0.000) (0.000) -0.573 Spreadpf + (0.000) Adjusted R2 0.0778 0.0777 0.0788

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Table 9 Post-Earnings Announcement Drift Regression

The statistics are based on a sample of 11,094 quarterly earnings announcements of Nasdaq-listed firms from 2003 through 2005. AR60 is the cumulative abnormal return sixty days following the earnings announcement. IBESpf is the portfolio rank of the difference between actual earnings and IBES forecasted earnings. SUVpf is the portfolio rank of a regression-based measure of unexplained volume using standard market-based methodology. IHpf is the portfolio rank of the percent of outstanding shares of the firm held by institutions in the quarter prior to the earnings announcement. IHpf is the portfolio rank of the change in institutional holdings one quarter prior to the earnings announcement. MktCappf is the portfolio rank of the total shares outstanding at the end of the prior quarter multiplied by the end-ofprior quarter price. Mkbookpf is the portfolio rank of the market capitalization of the firm at the end of the prior quarter scaled by total assets at the end of the prior quarter. ADVpf is the portfolio rank of the average daily trading volume of the firm over the quarter prior to the earnings announcement. Momentumpf is portfolio rank of the size-adjusted cumulative abnormal return in the quarter prior to the earnings announcement. Volatilitypf is the portfolio rank of the standard deviation of daily returns over the quarter prior to the earnings announcement ending on day T-5. Dependent Variable Intercept IBESpf IBESpf*SUVpf IBESpf*IHpf IBESpf*IHpf IBESpf*MktCappf IBESpf*Mkbookpf IBESpf*ADVpf IBESpf*Momentumpf IBESpf*Volatilitypf Adjusted R2 -2.806 (0.063) -0.410 (0.682) 1.053 (0.428) -1.543 (0.123) 0.371 (0.748) 0.0015 AR60 (1) -0.383 (0.290) 2.451 (0.050) 1.773 (0.046) (2) -0.395 (0.275) 3.275 (0.013) 1.746 (0.050) -0.541 (0.593) -1.829 (0.076) -3.309 (0.031) -0.316 (0.753) 1.895 (0.173) -1.312 (0.191) 0.683 (0.561) 0.0017

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