Companies Announcements and Share Prices: Evidence on the Saudi Stock Market
Announcements are essential for investors and shareholders in enabling them to determine the viability of their investments. According to the efficient market theory, stock prices in a semi-strong market factor all material public information. Therefore, any publicly issued financial announcement has the potential of influencing the demand for various stocks and subsequently affecting their prices. This paper examined whether announcements (annual financial results, change in board of directors /CEO, annual general meeting) result in significant changes in the price of stocks in Saudi Arabia. A sample of 183 public companies, whose stocks are traded in the Tadawul All Share Index (TASI) will be examined. A 31-day window, 15 days post-declaration and 15 days pre-declaration, will form the period through which the testing for abnormal returns using event study analysis will be done for each of the sample companies. The results of this analysis will show whether there is a positive relationship between the stock prices in the TASI and the announcements
Keywords: stock prices, earnings, shareholders, market efficiency, annual general meetings
Table of Contents
Section 1: Abstract 2
Section 2: Aims and Context of the Project 4
Section 3: Contribution to Knowledge and Statement of Significance. 6
Contribution to Knowledge. 6
Statement of Significance. 6
Section 4: Literature Review and Conceptual Framework. 7
Financial Results. 8
General Meetings. 11
Changes in Leadership (Board or CEO) 13
Event Study. 15
Section 5: Approach and Methodology. 17
Data Collection. 17
Data Analysis. 18
Formula for Expected Returns in Event Analysis. 19
Companies Announcements and Share Prices: Evidence on the Saudi Stock Market
This project aims at evaluating whether announcements of annual financial results, change in board of management or the CEO, and annual general meetings (AGM) by companies in Saudi Arabia have an effect on their stock prices on the Saudi Arabia stock exchange. This research proposal establishes the foundation for the examination of 183 companies in the Saudi Arabia Tadawul All Share Index (TASI) using event study methodology. This study will try to fill the main gaps in the previous literature by empirically investigating the impact of companies’ announcements on its share prices. The research will use an event-study analysis.
Information on a company’s financial performance is always essential for investors since it determines the value of stock prices and their potential future returns. In a stock market, the stock prices act as a barometer of all internal and external factors that affect a business. Accordingly, stock prices are not only indicators of the value of a company, but also representatives of the many economic and non-economic factors that may affect a particular business or sector. A company’s earnings usually indicate its profitability trend, and therefore gives investors vital information on whether they should buy or sell a particular stock. From this perspective, financial information acts as a yardstick in the capital market that assesses both the profitability and strength of a firm. Non-economic indicators, such as a change in management, are always indicators of the strategies adopted by a company. Since different strategies have varying effects on a business’ performance, these factors inevitably affect stock prices.
According to the efficient market hypothesis, which was established by Fama (1965), there are three types of market efficient: weak, semi-strong, and strong. In a weak market efficiency, the current stock prices factor in all past information. Further, changes in stock prices are random, and no investment strategy is applied. The semi-strong market suggests that current stock prices consider material public information and changes in the market. Therefore, changes in the stock prices in this market will result in unexpected public information, and investors may not get above average returns if they make investments based on such knowledge. Finally, in the strong form, insider trading is not rewarded since the stock prices factor all non-public information (Reilly & Brown, 2006, p. 36-39). Market efficiency does not occur on its own, and it depends mostly on the interpretational abilities of investors and how they apply the price-sensitive information in their dealings. Given that any major announcement is relevant for a business, it has the likelihood of affecting the prices of stocks in the market.
Although there have been many research studies that have focused on the effects of various types of announcements on share prices, few have focused on Saudi Arabia. This research will be essential for regulators and investors interested in the Saudi Arabia stock market. Among the regulators, the understanding of the volatility of the Saudi stock exchange market, with respect to the announcements of annual financial results, change in the board of management, and meetings will enable them to supervise the market more effectively so that investors can maximize returns and minimize losses (Matharu & Changle, 2015). Additionally, the information from this study will give investors crucial insight on how they can profit from the Saudi stock exchange market. According to Pritamani & Singal (2001), investors always have a chance of succeeding from inefficiencies in stock markets, especially those that have semi-strong form efficiency. Finally, this paper will set a basis for further study on the performance of stocks in the Saudi stock exchange after major financial announcements.
The main objective of this study is to test for the reaction of stock prices to company announcements on the Saudi Stock Exchange.
The companies’ announcements are:
- Annual financial results
- Changes in the position of the board of directors/CEO
- Convening of general assembly meeting
1- What is the impact of annual financial results announcements on stock price?
2- What is the impact of changes in the position of the board of directors/CEO announcements on stock price?
3- What is the impact of convening of general assembly meeting announcements on stock price?
One of the main importance of this research is expanding the existing knowledge spearheaded by Fama (1965) of the market efficiency in weak, semi-strong, and strong markets. In particular, the study will be crucial in establishing the market efficiency of the Saudi stock exchange, the Tadawul All-Share Index (TASI). This information will be essential in determining whether investors can make more than market average returns by using past information and technical analysis when making their trading decisions on the Saudi stock market. Therefore, the results of this study can form a good basis for testing the weak, semi-strong, and strong form of the efficient market hypothesis (EMH) in Saudi Arabia.
This research will significantly contribute to the operations of investors in Saudi Arabia,. In particular, the knowledge of how stocks react in the TASI following major financial-related announcements presents opportunities for individuals to profit from inefficiencies in the market. Investors in stock markets usually benefit through capital gains or dividends (Angelovska, 2017). Therefore, the ability to predict underpriced stocks gives investors an opportunity to make capital gains by purchasing underpriced stocks and selling them when their prices increase after an announcement. According to Keite and Uloza (2005), a semi-strong form of efficiency present opportunities for individuals to profit from the release of information in the stock market. Therefore, the knowledge of the behavior of the TASI relative to financial-related announcements as well as non-financial related, but essential business information will be beneficial to investors. For example, information on earning reflects the wealth and profitability of a company and indicates possible dividend incomes. As a result, the release of this information during an AGM or in a company’s seasonal financial results can impact the stock price movements (Hussin, Ahmed, & Ying, 2010).
It is agreed that capital markets always react to financial announcements such as those on earnings, dividends, annual general meetings, and a change in the composition of the board of directors or chief executive officer. In most countries, Saudi Arabia included, the provision of annual and seasonal financial statements such as balance sheet, cash flow, and income statement, of a company, is a legal requirement. The disclosure of a company’s earnings, in particular, has significant effects since it provides critical information on a firm’s past performance, which enables investors’ to forecast future performance and value of equity (Mlonzi, Kruger, & Nthoesane, 2011). Aharony and Swary (1980) opine that there is a positive correlation between the movements of stock prices and announcements, even after adjusting for contemporaneous earnings. Qureshi, Abdullah, and Imdadullah (2012) opine that the availability of financial information on a company’s earnings can cause a market response.
A company financial performance or profitability are communicated through an earnings announcements in a specific time. The earnings announcements usually occur annually, semiannually, or quarterly. During this period, a company releases balance sheet statements, income statements, cash flow statements, and other financial statements for a specific period. Besides fulfilling the legal obligation of providing the public with audited accounts of the company’s performance, by releasing these documents to the public, investors are able to forecast future performance (Mlonzi, Kruger, & Nthoesane, 2011). A study by Ball and Brown (1968) revealed that annual earnings announcement contain useful information that is not entirely incorporated into stock prices when released.
The reaction of stocks following the announcement of earnings has been widely explored by many researchers (Angelovska, 2017; Booth, Kallunki, Sahlstro, & Tyyenla, 2011). According to Corrado (2002, p. 565), insiders use information in financial statements for decision making and control while external parties use this information for decisions on how to invest, finance, and in the appraisal of their portfolios. In this regard, annual financial results provide investors with key information for shareholders and other stakeholders on the performance of the company, which is essential in enabling them to make rational decisions. According to Aharony and Swary (1980) managers use earnings to signal various important information about their organization’s financial and non-financial prospects. Additionally, they note that earnings give essential information about a company’s performance, which lead to immediate changes in stock prices after their announcement. In support, Black (1980) alleges that individuals who use financial statements consider earnings as indicators of the value of an organization. In this regard, the information given on earnings of the company can increase or decrease investors’ willingness to purchase, retain, or dispose specific stocks in their portfolios.
According to Sehgal and Bijoy (2015), it is always difficult for investment companies to accurately forecast on the returns of companies where that make up their portfolios. As a result, there is always an anomaly in the capital market between the actual earnings realized and the predicted earnings. This anomaly is referred to as the post-earnings announcement drift (PEAD). Beaver (1968) alleges that in the United States stock market, there is always an increase in trading activities and price volatility of securities in the period of announcements. The high volatility in the stock prices indicates the difficulty among investors in predicting the actual value of their securities. Supporting this observation, Bernard and Thomas (1990) opine that PEAD is caused by the method that researchers use to estimate the earnings surprise, which is dividing earnings less earnings forecast by a deflator.
A study by Chen, Cheng, and Gao (2005) in mainland China showed that firms that make early announcements surprise the market, which is shown by high volumes and price reactions. This behavior can be partly explained by that later announcements are usually more predictable, which is shown through low volume and price reactions. A research conducted by Ahmed et al. (2009) to establish the cause for the difficulty in forecasting earnings established that there is no particular reason for this variation. The researchers used a logistic regression and forecast data, and their data was from 1983 to 2004. Despite the difficulty in identifying single specific reasons for the variations between the forecasted and actual earnings, the researchers noted that these differentiations are reduced the presence of earnings characteristics that are similar to actual earnings. The firm characteristics that are identical with the quality of pre-announcement disclosures also reduces these variations. Finally, they noted that a firm’s characteristic that is similar to the cost of acquiring private information needed to estimate earnings also reduced the level of variations in forecasts. Overall, Ahmed et al. (2009) findings support that the efficiency of the capital market can be enhanced through more quality preannouncement information on earnings.
A study by Cready and Gurun (2010) to establish whether earnings information results in distinct market response in the NYSE and whether this reaction has a positive correlation with the direction of the announcement established that treasury bonds and implied future inflation correlate with the announcements. The study used samples of quarterly earnings from 3 January 1973 to 21 June 2006. They also used the combined NYSE and AMEX daily CRSP value-weighted and equal-weighted return indices. Cready and Gurun (2010) observed that there is some negative relationship between announcements on earnings and market return that exists past the intermediate market announcement period. Accordingly, the researchers established that investors do not immediately exploit the information on aggregate earning news.
Research by Cao and Narayanamoorthy (2011) established that low volatility in forecasted earnings result in high PEAD. The low volatilities in the forecasts ultimately mean that investors will have greater levels of surprise when actual earnings have a significant variation from the forecasts. Not only did the researchers establish that firms with lower earnings volatility have higher abnormal returns, they also discovered that these firms have low trading frictions. In sum, the findings showed that there is a negative correlation between high abnormal returns and trading frictions. In addition, the researches established that the PEAD returns due to earning volatility are not concentrated in firms with the largest trading frictions. In support, Sehgal and Bijoy (2015), note that PEAD is affected by both the magnitude of the earnings surprise and its persistence. Therefore, forecast that give almost similar observations for earnings among various analysts can result in the greatest shock, PEAD, if they have some variations from actual earnings.
According to Truong (2011), China stock markets experience some poste-earnings-announcement drift (PEAD) anomaly. The researcher used data for between 1994 and 2009 in his study. Further, the researcher observed that there is a positive correlation between PEAD and arbitrage risk. PEAD correlation with foreign ownership was found to be negative. An almost similar study by Liadroo and Grigaliuniene (2012) to examine the asymmetry in price reactions to announcements of quarterly earnings, showed that positive news result in more reactions in the Lithuanian stock market than negative news.
Despite various researches being studies on the effects of announcements on stock prices, Annual General Meetings have receive the least attention. During these meetings, managers and the CEO not only address the shareholders, but all stakeholders, including possible investors. Additionally, there are certain critical decisions that can only be passed in AGMs, such as the election of Board of Directors, and some key managerial announcements, that concern management view on the prospective of the company. Since the occurrence of AGMs are always known in advance, their impact majorly depends on the announcements made during these meetings.
A study by Berkeley (1985) to investigate the effects of AGM on stock returns showed that there is significant positive abnormal returns around the meeting dates. The researcher carried a random sample analysis in United States firms between 1978 and 1982. These results indicated that the general meetings did not have a significant impact on returns of the stock market. A research by Olib (2002) to investigate the effects of an AGM on trading turnover established that there were significantly high levels of fluctuations in stock returns 10 day pre-announcement and 10 days post-announcement of the meeting. The researchers sample was of United Kingdom companies that were listed in the United States market between 1994 and 1998. Interestingly, the AGMs did not affect the trading volume, which showed that the United States investors were not so concerned with the value of information from these forums.
Research by Giuseppe Gracia et al. (2010) on the effect of AGMs on stock returns, fluctuations, and trading volumes in the Spanish Stock Exchange from January 2002 to June 2009 showed that these meetings either on the exact date of occurrence or a few days to the event had not significant impact on any of them (In Omidpour & Talebnia, 2016). A study by Omidpour and Talebnia (2016) on the relationship between AGMs and stock returns, stock trading volumes, and stock return fluctuations among cement companies in the Tehran Stock exchange established that there is significant relationship between stock return of companies and also the volumes trades with holding an AGM. However, the research established that there is no significant relationship between stock return fluctuations of companies listed in the market with holding an AGM. The researchers used panel data analysis and panel data regression methods. They also made 29 observations in their study.
This study can extend the conclusions of Kalay and Lowenstein (1985) on the average abnormal high returns (AAR) of dividends after their announcement dates. This research was framed on the expected return and risk associated with predictable events that would generate new information. The researchers established that per unit risk on common stock is not static, rather it increases on the day of the event. AGMs like dividend announcements are known in advance by market participants, and they both supply the market with sensitive business information.
Another approach in analyzing the effects of AGM’s is the use of information asymmetry. Since AGMs are by nature a media event, managers and other executives can naturally prefer addressing bad news during the AGM, since this information can negatively impact the company’s market value than when this information is released in other days. Kothary el al. (2008) opines that managers can time when to release bad or good news. This argument is founded on the agency theory, and supported by the existence of information asymmetry between investors/ shareholders and the company’s management. In particular, they hold bad news with the hope that the situation will reverse itself and thus will never have to disclose the issue. Patell and Wolfson (1982) also note that managers prefer to release good news when the stock markets are open and bad news when the markets are closed.
There is no common resolve on the effect of a change in the composition of a company’s board of management or Chief Executive Officer (CEO) on stock prices. According to some studies, the leadership in large organizations does not matter since these individuals are unable by themselves to alter their performance, since large organizations usually run themselves (Hofer & Schendel, 1978, p. 102). In other studies, leadership is found to matter, however, the challenges and disruptions caused by successions cancel the positive effects of replacing non-performing managers or CEOs (Weiner & Mahoney, 1981). Still, some research findings have established whether a leader has a positive, neutral, or negative impact on an organization’s performance depends on how perfectly his/her character matches the job requirements (Hambrick & Mason, 1984). Nonetheless, studies have not yet established contingent factors that explain when there may be a positive succession-performance relationship in a large corporation (Friedman & Singh, 1989, p. 720).
Although there are various external mechanisms such as takeovers that can result in the removal of inefficient the boards members or CEOs, there are still many important mechanism through which these individuals can be replaced. One method is self-monitoring of the board of directors (Fama, 1980). There is also use of mutual monitoring among firm’s managers. Lastly, is the monitoring of company’s by large shareholders (Warner, Watts, & Wruck, 1987). Where the monitoring mechanisms are effective, the stock prices of company’s always reflect information on managers’ and senior leaders’ efficiency. Hence, there is a negative relationship between a change in top management/ leadership and share performance (Warner, Watts, & Wruck, 1987).
According to Warner Watts, and Wruck (1987), a logit analysis of effects of change in leadership of a company and its stock prices show that there is a negative relationship between the probability of a change of top management and share performance. Unfortunately, logit models have a predictive ability when there is extremely good or bad performances. Further, Warner Watts, and Wruck (1987), note that event study results show that individual results have a minimal stock price reaction following the announcement of a top management change.
A study by Cool and van Praag (2007) established that there is no significant market reaction to top CEO turnover announcement in Netherlands. The researchers used a stock price movement and trading volume approaches to examine the market reaction with respect to the company. According to research findings from 39 non-routine changes and voluntary changes from 1994 to 1998 conducted by Neomann and Voetmann (2005), there is a positive result on non-routine changes and negative ones to voluntary changes. Similarly, Setiawan (2007) observed that Indonesian investors react to non-routine turnovers of CEOs when a successor is appointed from outside the firm.
There are various causes of CEO changes. Some changes may follow good or poor financial, while others may have no relationship to prior business performance. The common form of changes include termination, a change involving outsiders, and CEO change, which normally entail a succession plan. The stock plan reaction to changes in leadership indicates whether the capital market considers these events significant (Warner, Watts, & Wruck, 1987). Wruck, Watts, & Wruck (1987) note that the prediction on the sign of the abnormal stock price effect at announcement are usually never precise, even where changes are made to address cases of poor performance. This problem is essentially due to the fact that a change can convey more than one information. For example, a change can signal the probability of a firm having worse than anticipated results, and at the same time a positive component if the change has been made in shareholders’ interests (Warner, Watts, & Wruck, 1987).
Event studies help researchers to evaluate whether there is any relationships between an event and fluctuations in stock prices through monitoring of the changes in stock prices and the emergence of abnormal returns (Angelovska, 2017). The event study methods considers that since investors in the stockholders are rational they will react to any announcements made, in turn, making the changes in the financial market to be reflected immediately in security prices. To examine the magnitude of this impact, analysts can simply assesses the variations in price of a security a few days before and after an event (Dolly, 1939). The original event study model was developed by Dolly (1939), and after slight modification by Fama, Fisher, Jensen, and Roll (1969), the model format has remained the same. Therefore, the current model is based on the table layout and the classical stock split event study that was established by Fama et al. (1969). Further, this model focuses on sample securities’ mean and cumulative return during an event.
The underlying concept in the stock market is that investors are rational and they consider any new information in the market. Therefore, anomalies in the market only occurs for a short period since investors notice their presence and respond appropriately by either buying or selling a stock (Angelovska, 2017). This view is supported by Shiller (2003), who asserts that when people who are irrationally optimistic buy stocks, the smart ones sell them and when the unreasonably pessimistic sell, the smart ones buy. This tendency has an overall effect of eliminating irrational traders and re-balancing the market, as postulated in Fama’s (1965) efficiency market theory. Nonetheless, Angelovska (2017) highlights that this system does not work perfectly in the real-world, as proven by many asset bubbles.
H0: Share prices react positively to positive annual financial results announcements.
H1: Share prices do not react positively to positive annual financial results announcements.
H0: Share prices react positively to announcements of changes in the position of the board of directors/CEO a.
H1: Share prices do not react positively to announcements of changes in the position of the board of directors/ CEO.
H0: Share prices react positively to announcements of the convening of general assembly meeting.
H1: Share prices do not react positively to the announcements of the convening of a general assembly meeting.
My research extends previous studies on the effect of financial reports, general assembly meeting, and the change in leadership announcements on stock prices. From Bitok et al. (2011), Andre et al. (2011), and Majanga (2015) research, there is a significant relationship between investments sentiments and stock price movements. In the signaling hypothesis, earnings reflect expected future cash flows and thus influence how investors’ react, and the subsequent performance of stock prices (Aharony & Swary 1980).
Few studies have focused on the investors’ sentiments and psychological state on stock price movements. A study by Bitok et al. (2011) established that there is a significant relationship between investor’s sentiments and psychology and stock price movements. Therefore, how shareholders’ react after announcements greatly determines how the stock prices move (Majanga, 2015). Accordingly, Majanga (2015) opines that the increase in stock prices follows a demand and supply theory.
I will use daily data from January 2017 to December 2017 to determine the price sensitivity of stock prices to earnings announcements. My research will focus on 183 companies that are in the Saudi Arabia stock exchange, the Tadawul All-Share Index (TASI). I will use the event study methodology designed by Brown and Warner (1985) to tests the abnormal returns for the stocks in this study. The study window for the analysis is defined as 15 days before the announcements and 15 days after the announcement (annual financial results, change in board of directors /CEO, annual general meeting). My null hypothesis is that share prices in Saudi Arabia react positively to positive annual financial results, change in board of directors /CEO, and annual general meetings announcements.
The event study methodology will be used in this paper to analyze for abnormal performance in the stock market when earnings are announced. The event study methodology helps a person examine the changes in the price of stocks after the announcement of earnings. Since this study starts by examining the stock prices a few days before the actual announcement and ends a few days after the event, it can identify whether there are abnormal returns that are due to the anticipated event.
This research is based on the Fama et al. (1969) study, which examines whether there are abnormal returns in each day. An abnormal return is simply the difference between the observable realized return in the market and the benchmark return. Noteworthy, benchmark return refers to the possible incomes from stock when there are no events (Angelovska, 2017). By definition, the abnormal return is actually the residual in a market model. It can be established in the following manner:
Rit = αi + βmt + εt
εit = ARit = Ri,t – α –βi Rmt
Ri,t is the return of stock i,
Rmt is the return of the market index,
βi is the systemic risk of stock i,
The coefficients of the market model are tested separately using the non-event return data for each event using the ordinary least square regression (OLS) (Angelovska, 2017). Predication of Ri,t are established using the estimated coefficients α and βi. Therefore, the abnormal return of security i on event day t ARit is calculated using the following equation.
εit = ARit = Ri,t – α –βi Rmt
The mean abnormal return for observations in day t is the sum of individual abnormal returns on day t divided by the number of events (N) (Angelovska, 2017). The parameters of the market model, such as the alphas and betas, which are based on the returns of stocks in the market index for the estimated period, are first estimated. The expected returns on the stock are later calculated using the market model. Each return is categorized into two; returns attributable to market movements and returns attributable to the announcement (annual financial results, change in board of directors /CEO, annual general meeting). To measure how the stock price responds to each announcement, I will first eliminate the effects of the stock observed rate of return. The market model is based on the fact that stock returns are largely influenced market factors. This factor is captured through beta in the market model. In this regard, the market model relates the returns of any stock with market-linear fashion. The model applied for the analysis is CAPM for expected rate of returns for selected stocks.
E(R) = Expected returns,
ARit = Abnormal returns
εit = error term,
Rit = Actual returns
AAR = Average Abnormal Returns,
CAAR = Cumulative Average Abnormal Returns,
A paired t-test for varied event windows will be used to test the final hypotheses (Appendix 1). Noteworthy, each of the three announcements (annual financial results, change in board of directors /CEO, annual general meeting) will be analyzed separately.
Studies on market efficiency in the semi-strong market suggest that stock prices reflect all past public information. Therefore, when based on the efficient market theory, any public announcement issued by the business should not result in any significant changes in the stock prices. In reality; however, no market can be perfectly efficient. In this regard, I expect that there will be some deviations. The presence of anomalies in the Tadawul, after announcements, after major announcements, such as earnings, AGM, change in leadership (CEO), can result in significant movements in the prices of securities as investors react to these news. In this regard, it is quite possible to examine whether announcements on earnings, AGM, or change in leadership (CEO) result in significant changes Tadawul All-Share Index, and subsequently the characteristics of the EMH (weak, semi-strong, or strong) of the market. Importantly, this information can help investors establish appropriate strategies of exploiting the Saudi Arabia stock market.
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|Event Time||Average AAR||Average CAAR||t- Statistic for AAR||t-Statistic for CAAR|