An empirical investigation of the information content of profit warnings announcements for companies quoted at the NSE

Abstract

There are several theories that have been advanced to explain why companies issue profit warning announcements. A major reason advanced as motivation for issuing of profit warnings is the avoidance of shareholder lawsuits over failure by management to provide timely negative information. Other reasons include need to comply with regulatory requirements besides being used as a strategy by management to affect the overall market reaction to earnings news based on the assumed informational value. A mandated disclosure requirement was issued by the Capital Markets Authority (CMA) through legal notice no 60 of May 2002 stipulating that, an issuer shall disclose all material information and make a public announcement of any profit warning, where there is a material discrepancy between the projected earnings for the current financial year and the level of earnings in the previous financial year. This paper examined the information content of profit warning announcements at the Nairobi Stock Exchange. This was achieved by studying fourteen companies that had issued profit warning between the periods 2002 to 2010.The study made use of the stock returns and market returns data to determine whether profit warning announcement elicit any reaction in the Kenyan stock market. The study made use of daily adjusted prices for sample stocks for the event window of 31 days, consisting of 15 days before and 15 days after the profit warning announcement. The event study methodology was employed in the determination of the effects of the profit warning announcement. Abnormal returns were calculated by use of the market model and tests are conducted to test the significance. The study found out that the Kenyan Stock market reacts negatively to profit warning announcements as shown by a general decline in mean abnormal returns around the profit warning announcement period. This is consistent with the hypothesis that profit warnings have information content which is associated with a negative revaluation of the firm. The study equally found out that there are negative abnormal returns that are statistically significant at 5% level, around the profit warning announcement date. There is therefore evidence of investor reaction before and after the profit warning announcement.