Underreaction to industry-wide earnings and the post-forecast revision drift

Abstract

We test whether the post-forecast revision drift is mainly attributable to investors' underreaction to industry-wide earnings news conveyed by analysts' forecast revisions. We find a large drift associated with industry-wide earnings news but no drift associated with firm-specific earnings news. Consistent with the functional fixation hypothesis, we provide evidence that the postforecast revision drift is driven by investors' underreaction to the higher persistence of industry-wide earnings. Although prior research has focused on differential persistence of earnings components stemming from managerial reporting discretion, we provide evidence suggesting that investors do not fully understand the differential earnings persistence attributable to industry fundamentals. © University of Chicago on behalf of the Accounting Research Center, 2013.