The effect of meeting or missing earnings expectations on information asymmetry

We examine whether the previously documented pricing premium for firms' equity when they meet or beat earnings expectations (MBE) is attributable to a reduction in the cost of equity capital via a reduction in information asymmetry. We measure the latter using the probability of informed trading (PIN) from Easley et al. (1997). We find that PIN decreases (increases) when firms meet or beat (miss) earnings expectations and that these changes increase with the magnitude of the earnings surprise. In addition, firms that regularly MBE show a stronger decline in PIN compared with those achieving MBE irregularly. Furthermore, we find that the reduction in asymmetry for MBE firms disappears in cases where expectations management was likely used to meet the earnings benchmark, but we find no evidence that earnings management affects the reduction in asymmetry attributable to MBE. Broadly, our results correspond to findings regarding the pricing premium associated with MBE, suggesting that the MBE pricing premium is at least partially attributable to a "denominator effect where investors discount future cash flows at lower rates because of reduced levels of information asymmetry.