Implications of Transaction Costs for the Post-Earnings-Announcement

This paper examines the effect of transaction costs on the post-earnings-announcement drift (PEAD). Using a variety of measures of transaction costs, we provide evidence that the transaction costs of the shares of the firms in the extreme earnings surprises portfolios are larger than the transaction costs of the shares of the firms in the moderate earnings surprises portfolios. When we measure profitability after transaction costs, our results indicate that profits of implementing the PEAD trading strategy are significantly reduced by transaction costs. Using portfolio and regression analyses, we also show that firms with higher transaction costs are the ones that provide the high abnormal returns for the PEAD trading strategy. This result is consistent with transaction costs creating limits to arbitrage that hinder the full convergence of price at the time of the earnings announcement.