1999 in addition johnson 2004 employs the equity call

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1999 ). In addition, Johnson ( 2004 ) employs the equity call option argument as an alternative explanation for the negative association between forecast dispersion and future returns documented in Diether et al. ( 2002 ). If forecast dispersion proxies for idiosyncratic uncertainty about future cash flows, then contemporaneous prices should increase with forecast dispersion, affecting future returns relative to other similar firms. Johnson ( 2004 ) provides additional support for this interpretation. We employ an event study research design using a narrow returns window surrounding earnings announcements. Our study is meant to provide additional evidence on whether and in what direction the market reacts to changes in belief dispersion surrounding earnings announcements. 9 Our study differs from the existing research in several respects. Most important, we focus on the information content of accounting data in that we examine the relation between changes in forecast dispersion and equity returns within a narrow window surrounding the earnings announcement. We thus can provide evidence as to whether earnings announcements are a source of information that affects differences in the uncertainty of cash flows across investors. Taken as a whole, prior research is unclear on whether investors respond to information contained within earnings announcements that is related to dispersion in investor beliefs. It is also unclear whether the change in forecast dispersion is a proxy for risk that is priced negatively by the market, a proxy for the option value of equity that is priced positively by the market, or evidence of the extent to which stocks are mispriced. Our study further differs from prior research in that we employ extensive controls for nonlinearities in the returns/earnings relation and other earnings related information that can influence stock price. Besides enhancing the validity of our results, these controls allow us to eliminate additional competing hypotheses and address other interesting questions related to the valuation effects of meeting certain earnings thresholds. Finally, our research design employs several methodological improvements, including the use of individual analysts’ forecast data (as opposed to summary data) from the I/B/E/S unadjusted detail file. The benefits obtained from using these data are nontrivial and discussed in the next section when we present our research design. 3 Research design Our proxy for the change in dispersion of investor beliefs is the change in dispersion in analysts’ forecasts of next quarter’s earnings around the current quarter’s earnings 9 We note that firms frequently conduct conference calls and provide much information within an earnings announcement that might be unrelated to current period earnings. Thus, the change in dispersion of investor beliefs that we examine could be due to other information released simultaneously with earnings.
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