Competitors’ Effect Literature

There were some studies in the area. Many of them – Foster (1981), Joh and Jevons Lee (1992), Baginski (1987) analysed the effect of earnings announcements or earnings forecasts on the announcing firm and other companies within the industry. Earnings releases do fall into category of “news releases”. Unlike with most news, it is easier to judge whether the earnings announcement was a positive event, by comparing the earnings with the analysts’ estimates or previous earnings.

Foster (1981), identified a sample of 10 industries with a total of 75 firms. All industries have from 5 to 11 firms, which falls in the oligopoly and somewhat into the monopolistic competition criteria. He also had a “Dominant Firm” criterion, which only identified large companies from the sample, leaving only 40 out of 75, which better suits the Oligopoly category. A test was conducted that analysed the correlation between the earnings release and abnormal returns on the days around the announcement day. The results showed no statistical significance between the earnings releases and abnormal returns. They, however, showed a very strong correlation between companies’ returns on the announcement day – 0.94. This fact supports the information transfer hypothesis. Moreover, a sample with more specialized firms (less-diversified business) showed even stronger rate of information transfer. Foster (1981) then showed that a positive earnings announcement for a company almost always (the correlation coefficient is 1 or 0.94 in different samples) corresponds to a positive reaction in the stock return of other companies in the industry. Overall, the work suggests that “information transfers [] are empirically significant” (Foster 1981, pp. 224).

Baginski (1987) conducted a similar research, but he tested the effect of earnings forecasts instead of the releases and he ran a trading simulation to test the data. The trading simulation uses the return of the forecasting firm as given and makes according transactions with the stocks of other companies within the industry. That is, if a company had a positive earnings forecast, a long position is opened in the stocks of other companies, and if the forecast was negative, a short position is executed. He concluded that the results are similar to Foster (1981) – there is information transfer and it is supported by a trading simulation.

Joh and Lee (1992) worked with oligopolies and earnings announcements. Company’s earnings increase if their sales increase, costs shrink or a mixture of both happens. So they separated the earnings into sales and costs, arguing that the increase in sales is an industry-wide event and therefore all the firms adjust in the same direction (hypothesis 1). The costs, however, are firm-specific and therefore a cost reduction for firm A is a bad event for its competitors (hypothesis 2). According to Joh and Lee (1992), industry-wide cost changes are announced in media and prices adjust accordingly, while unexpected cost changes are reported by the earnings releases and are firm-specific. Their data supported the hypothesis 1 at 10% significance level and hypothesis 2 at 1% significance level. They explain strong information transfer due to the sample consisting of homogeneous oligopolies; therefore the companies are very similar and are more vulnerable to actions of the competitor(s).

Jarrel and Peltzman (1985) studied the effect of product recalls on the share price. In addition to the decrease in the share price of the recalling company competitors’ shares drop too. The competitors’ share price decrease is around 66% of the decrease of the recalling company (Jarrel and Peltzman 1985, pp. 532). They argue that the gain from the product substitution effect is suppressed by the decrease in the demand for goods of the industry and thus returns of both the guilty company and its competitors are negative.

The studies agree in common that some events are positive (or negative) for both the announcer and its competitor. Foster (1981), Baginski (1987), Han and Wild (1990) state that an increase in the earnings of company A positively correlates with an increase in share prices with other companies in the industry. Jarrel and Peltzman (1985) add that product recall has positive correlation in negative returns between competitors. These findings are consistent with the situation Y.

Joh and Lee (1992) also give evidence for negative correlation between competitors’ returns in case of firm-specific cost reduction, which is consistent with the situation X.

Some events, however, may not affect other firms at all. Hertzel (1991) studied share repurchases’ effect on competitors’ stock prices. Share repurchases increase the stock price for the announcing company. Insignificant negative returns in competitors’ share prices were observed with the exception of Dominant Firm industry specification sample, where all firms within the industry have at least 10% of market share. Firms in this category had significant negative returns. However, the sample is small and the author concluded that share repurchases affect the repurchasing company only. Overall the study does not fall into any situation category, but the Dominant Firm sample is an oligopolistic market and its effects comply with the situation X.

Date: 2015-12-17; view: 827