Intra-Industry Information Transfers - Profit Warnings

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Table of Contents
List of Tables.............................................................................................................................2
List of Figures...........................................................................................................................2
Chapter 1: Introduction...........................................................................................................3
Chapter 2: Literature Review.................................................................................................6
2.1. Information transfers.......................................................................................................7
2.2. Profit Warnings................................................................................................................8
Chapter 3: Hypotheses Development...................................................................................13
3.1. Market Reaction to Profit Warnings..............................................................................13
3.2. Factors That May Influence the Effects of Profit Warnings on the Industry.................14
Chapter 4: Sample Data and Methodology..........................................................................16
4.1. Sample Data...................................................................................................................16
4.2. Event Study ..................................................................................................................17
4.3. Cross-Sectional Regression Analysis............................................................................19
Chapter 5: Descriptive Statistics...........................................................................................21
5.1. Characteristics of Profit Warnings.................................................................................21
Chapter 6: Results..................................................................................................................29
6.1. Event Study Results – Full Sample...............................................................................29
6.2. Event Study Results – Industry-Wide Sub Sample.......................................................34
6.3. Event Study Results – Firm-specific Sub Sample.........................................................38
6.4. Multivariate Cross-Sectional Analysis – Full Sample...................................................42
6.5. Multivariate Cross-Sectional Analysis – Industry Wide Sub-Sample...........................44
6.6. Multivariate Cross-Sectional Analysis – Firm Specific Sub-Sample............................46
Chapter 7: Conclusion...........................................................................................................47
7.1. Conclusions and Implications........................................................................................47
7.2. Limitations of the Study................................................................................................51
7.3. Suggestions for Further Research..................................................................................52
Bibliography...........................................................................................................................54
Appendix A: Profit Warning Classification.......................................................................A.1
A.1. Characteristics of Industry-Wide and Firm Specific Profit Warnings........................A.1
A.2. Examples of Profit Warnings and their Classification................................................A.1
Appendix B: Distribution of Average Abnormal Returns................................................B.1
List of Tables
Table 1: Profit Warnings segmented by source of warning......................................................21
Table 2: Frequency Distribution of industries for announcing and non-announcing firms.....23
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Table 3: Summary Statistics and Pearson correlations - Full Sample......................................26

Table 4: Summary Statistics and Pearson Correlations - Industry Wide Sub-sample..............26
Table 5: Summary Statistics and Pearson Correlations – Firm Specific Sub-sample..............26
Table 6: Test of Significance between ACAR of Announcing and Non-Announcing Firms...27
Table 7: Accounting Ratios for Companies making Profit Warnings......................................28
Table 8: Effects on Returns in Response to Announcements - Full Sample............................30
Table 9: Effects on Returns in Response to Announcements – Industry-Wide Sub Sample. . .34
Table 10: Effects on Returns in Response to Announcements – Firm-Specific Sub Sample. .38
Table 11: Cross-Sectional Multivariate Model Results - Full Sample.....................................42
Table 12: Multivariate Cross-Sectional Analysis - Industry Wide Sub-Sample Results..........44
Table 13: Multivariate Cross-Sectional Analysis – Firm Specific Sub-Sample - Results.......46
List of Figures
Figure 1: AAR and ACAR for Full Sample of Announcing Firms..........................................32
Figure 2: AAR and ACAR for Industry-Wide Sub Sample of Announcing Firms..................36
Figure 3: AAR and ACAR for Industry-Wide Sub Sample of Announcing Firms..................37
Figure 4: AAR and ACAR for Firm-Specific Sub Sample of Announcing Firms...................40
Figure 5: AAR for Firm-Specific Sub Sample of Non-Announcing Firms.............................41
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Chapter 1: Introduction
Perhaps the simplest way of rephrasing the heading of this study is as follows: Is there a
difference between the share price behaviour of non-announcing firms in response to firm
specific and industry-wide announcements as pertaining to profit warnings.
This document is a study of intra-industry information transfer between the returns of firms
releasing information, through profit warnings, and those of non-announcing firms in the
same industry. Many intra-industry information transfer studies have been conducted in the
past but in different contexts such as; mergers, stock repurchases, dividend omissions and
bankruptcy announcements. There have also been prior studies which studied the market
reaction to profit warnings in the announcing firm, however little research has been done in
the area of industry wide information transfers due to profit warnings and thus this study
intends to increase our knowledge in this area.
This study aims to evaluate the impact of a profit warning on the announcing company’s own
share price behaviour and the share price behaviour of other companies in the same industry.
Jin () notes that a significant shortcoming of previous studies is that they failed to distinguish
between firm specific factors and industry-wide factors; as a result this study treats industry
factors (profit warnings) and firm specific factors (profit warnings) separately in an attempt
to accurately describe the intra-industry information transfer and hence derive proper
meaningful conclusions.
The results of this study suggest that announcements that convey industry wide information
cause the announcing company and the non-announcing companies in the industry significant
negative cumulative abnormal returns. This observation implies that the information
conveyed in the warning was new information to the market, for both the announcing
company and the non-announcing companies, and thus caused the abnormal movement of the
share price. Our research also showed that profit warnings for companies conveying company
specific information caused negative abnormal returns for the announcing company; however
it did not have the same negative abnormal effect for non-announcing companies in the same
industry. This indicates that the market only gains new information about the announcing
company from the company specific profit warning as shown by the insignificant abnormal
returns for the non-announcing companies, as expected.
The cross-sectional regression of the full sample demonstrates the intra-industry effect of
profit warnings since it shows that the size of the effect of the profit warning on the
announcing company affects the size of the abnormal returns for non-announcing companies
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in the industry. The larger the market reaction for the announcing companies the lager the
market reaction for non-announcing companies. We also found that in the full sample the
intra-industry effect is more prevalent depending on the Earnings to Price ratio for the
announcing company; the higher the EPR the more negative the cumulative abnormal returns
in non-announcing companies.
The regression of the industry wide information sub-sample shows that the intra-industry
effect is influenced by not only the size of the market response on the share price and the
market capitalisation of the announcing firm but also the homogeneity of the services/
product offered of the industry. With respect to the market reaction, the greater the market
response on the announcing company’s share price, the greater the affect on the non-
announcing companies’ share price. With respect to the size of market capitalisation, the
greater the size of the announcing company the greater the abnormal returns for the non-
announcing companies. The homogeneity of the industry looks at how similar the services/
product offered is and it was found that, for the industry wide sub-sample, the more
homogenous the industry the less the abnormal returns were found to be for the non-
announcing companies. This finding for the homogeneous industry group is against our
expectations and suggests that homogeneous industries provide an environment conducive to
competitive reactions.
For the company specific profit warning sub-sample it was found that there was no real
significant relationship between the variables we tested, except for the size of the announcing
company, thus suggesting the lack of an intra-industry effect. This seems plausible since there
is no real reason for abnormal returns of the non-announcing companies for problems directly
related to another company only. The results did however show that the greater the size of the
announcing company the less the cumulative abnormal returns on the non-announcing
companies, this could be due to more information generally being available for large
companies so less of a market response.
The following chapters of this study are structured as follows: Chapter 2 comprises the
literature review, encompassing a summary of literature as pertaining to profit warnings and
intra-industry information transfers. Chapter 3 deals with the hypothesis development, in this
section our hypotheses are derived and defined. Chapter 4 relates to the methodology used in
the data collection process as well as the hypothesis testing procedures. Chapter 5 contains
the descriptive statistics followed by the detailed results of the study (in Chapter 6). Chapter 7
contains the detailed conclusions as well as recommendations for further studies.
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___________________________________________________________________________
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Chapter 2: Literature Review

Many studies have reported an association between the returns of firms releasing information
and those of non-announcing firms in the same industry. This relation is known as intra-
industry information transfer and has been documented in different contexts such as mergers,
stock repurchases(), dividend omissions and initiations(), and bankruptcy announcements(),
but little or no research has been done in relation to profit warnings. Several studies in the
past have investigated intra-industry information transfer of earnings related information such
as those by Jin () and Baginski (), but neither of these considered the effects of the
announcements on announcing and non-announcing firms in the industry separately.
Jackson and Madura () and Elayan, Meyer and Sun ()found that there is a strong negative
response to profit warnings. They also noted that the share price of the announcing firm
began to be affected about five days before the warning is issued and continued to decrease
for up to five days after, with little or no overreaction to the announcement.
Previous studies by Lang and Stulz() and Caton, Goh and Kohers ()also show that, on
average, the information transfer preserves the implication of the news, that is; if a firm
releases good (bad) news, the market perceives the non-announcing firms to have good (bad)
news.
Several studies show that there are considerable incentives for management to announce
profit warnings in a timely manner despite the fact that they are considered as voluntary
disclosures left to the management’s discretion. Skinner (), Lang and Lundholm() and
Richardson, Teoh and Wysocki() all give different reasons why it is in the managements
interests to disclose information to the public.
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Literature Review P a g e | 12
2.1. Information transfers

Intra-industry information transfer is described as the process whereby information
conveyed to the market about one firm (the announcing firm) conveys value-relevant
information about other non-announcing firms operating in that industry.1
Firth’s () study marked the beginning of the information transfer literature which grew out
of Ball and Brown’s () results. Firth () finds that other information sources, besides
conventional sources (such as interim reports) used to anticipate the firm’s annual earnings
announcement included the financial results of closely competing firms. Firth () finds that
investors used information contained in the announcement of financial results to re-evaluate
the share prices not only of the company whose results are being announced, but also of
closely competing companies in the same industry.
Prior research has also focused on the information transfer associated with management
earnings forecasts. Baginski () used earnings forecast data to test the hypothesis that the
sign of the earnings of announcing firms conveyed value relevant information to
shareholders of non-announcing firms. The result is consistent with that of Firth () in terms
of earnings forecast data.
Other studies have studied information transfers resulting from events other than earnings
announcements and management forecasts. Caton, Goh and Kohers () find that a dividend
omission announcement transmits unfavourable information across the announcing
company's industry that affects cash flow expectations and ultimately stock prices. Other
studies have found evidence of spill over effects associated with mergers, stock repurchases,
and nuclear and chemical plant accidents.
As stated earlier Jin () determines that a common shortcoming of earlier studies is that they
failed to distinguish industry common factors from firm specific factors. Industry-wide
factors are those that are common to the entire industry, and the effects of which will be felt
among all firms in that industry, while firm specific factors are factors that affect only the
one firm. Since it is reasonable to assume that industry common factors cause intra-industry
information transfers, co-mingling industry factors with firm specific factors may lead to an
inaccurate description of the intra-industry information transfer issue and hence improper
conclusions about it. A signal about industry common factors should affect security prices
of the announcing firm as well as other firms in the same industry. But a signal about firm
specific factors (with no resultant competitive shift) should affect security prices of the
announcing firm only.
1
Usually resulting in a material movement in the reference price of the non-announcing firmswithin the
industry
2.2. Profit Warnings

A profit warning is an announcement by a publically traded company in which the company
advises that its earnings won't meet analyst expectations. Profit warnings form part of
management’s voluntary financial disclosures, and as such they are not mandated by any
regulatory body, and it is purely up to the discretion of management as whether to make
profit warning announcements or not.
2.2.1. Management’s Incentives to Disclose information
Disclosure in this context implies the act of releasing all relevant information pertaining
to a company that may influence an investment decision. To make investing as fair as
possible for everyone, companies must disclose both good and bad information. In the
past, selective disclosure was a serious problem for investors because insiders would
frequently take advantage of information for their own gain - at the expense of the
general investing public. Disclosure of financial information with regards to a publically
listed company will lead to a reduction in the asymmetric information between company
insiders and its investors (or the general public). Asymmetric information is a situation in
which one party in a transaction has more or superior information compared to another.
This often happens in transactions where the seller knows more than the buyer; this
could be a harmful situation because one party can take advantage of the other party’s
lack of knowledge(). With increased advancements in technology, asymmetric
information has been on the decline as a result of more and more people being able to
easily access all types of information.
While it may be clear as to why management might want to disclose ‘good news’ there is
also benefit that can be obtained by disclosing ‘bad news’ to the public as well.
Managers may damage their reputations if they consistently fail to disclose bad news in a
timely and appropriate manner (). Failing to disclose bad news consistently will also
have further negative consequences, analysts will become less likely to follow the firm,
thus reducing liquidity and hence the firm’s stock price will suffer. Lang and Lundholm()
find that increased voluntary disclosure lowers the cost of information acquisition for
analysts and therefore increases their supply; This results in increased investor following,
reduced information asymmetry and greater demand for a firm’s shares leading to a
lower cost of capital, thus a net benefit for the firm despite the ‘bad news’.
Another incentive or benefit that managers may derive from disclosure of bad news
relates to an attempt by management to “walk down” financial analysts’ forecasts of
earnings to beatable targets. The argument is that managers release disclosures during the
year that guide financial analysts to believe that end-of-period earnings will be lower
than the actual announced earnings. This would generate good news on the official
announcement date since actual earnings will be above the recent expectations (based on
the profit warning statement) the result would be a positive share price reaction at the
earnings announcement date. The intentional “walk down” of analysts’ forecasts may be
justified by management’s expectations that the capital market punishment for reporting
a negative surprise at announcement date is greater than the reward from reporting a
positive surprise. Richardson, Teoh and Wysocki(), a U.S. study provides evidence that
firms walk down analysts (it should perhaps be noted that no relevant studies were found
for the South African market – but this does not imply that firms do not walk down
analysts in South Africa).
There is also a legal incentive for management to disclose information to the public in
that profit warnings act to help mitigate the legal liability of managers. Shareholders may
sue when there are consistent large stock price declines on earnings announcement days,
since shareholders can allege that managers failed to disclose adverse earnings news
promptly and appropriately(); and as a result they can claim that due to the manager’s
failure to promptly disclose material bad news they bought overvalued stocks that
devalued after management revealed this information.
The Johannesburg Stock Exchange (JSE) also obliges companies to keep investors
informed in a timely manner about any material, price-relevant information2. The
incentive behind such disclosure regulations is to encourage informed decision making
by all parties to securities transactions and hence to decrease asymmetric information
between insiders and outsiders. Compliance to the listing rules of the JSE is mandatory
for all listed companies and failure to comply may result in a civil or criminal liability
and may result in a number of sanctions including suspension of trading or de-listing of
the company. It should be noted here that Profit warnings are considered as voluntary
price sensitive announcements and as a result companies have no obligation to issue
them, unless not doing so would breach the listing requirements (as given at the bottom
of the previous page).
It should also be noted that according to Skinner’s () findings and those of Collett () both
the number of negative trading disclosures and their absolute impact is much higher than
the number and impact of positive announcements in the United States. This could be
explained by the fact that Shareholders are more likely to mount a class action if bad
news is withheld than good news. Similarly, fund managers will look more favourably on
directors who deliver company performance above expectation.
Another incentive for disclosure is the existence of Employee Stock Option Plans
(ESOPs). As Aboody and Kaznik () suggest, management makes opportunistic voluntary
disclosure decisions that maximize their stock option compensation, this is done by
disclosing bad news before the award of ESOPs in order to depress the share price and
hence the option exercise price, which is set at the market price at the date of award.
2
JSE Listing Rule 3.4 – under General Obligation of Disclosure states that the following provisions
apply in respect of material price sensitive information:
With the exception of trading statements, an issuer must, without delay, unless the information is kept confidential for a
limited period of time in terms of paragraph 3.6, release an announcement providing details of any
development(s) in such issuer’s sphere of activity that is/are not public knowledge and which may, by virtue
of its/their effect(s), lead to material movements of the reference price of such issuer’s listed securities.
With regards to Cautionary announcements Cautionary announcements listing rule 3.9 states that:
Immediately after an issuer acquires knowledge of any material price sensitive information and the
necessary degree of confidentiality of such information cannot be maintained or if the issuer suspects that
confidentiality has or may have been breached, an issuer must publish a cautionary announcement
(complying with paragraph 11.40). An issuer that has published a cautionary announcement must provide
updates thereon in the required manner and within the time limits prescribed in paragraph 11.41.
2.2.2. Market Reaction to Profit Warnings

Since profit warnings issued by firms generally indicate “bad news” in relation to the
previously anticipated firm’s annual earnings it is logical that the market reaction to a
profit warning announcement will be negative. Many studies such as the one by Jackson
and Madura ()confirm this expectation.3
Jackson and Madura’s study also confirms the presence of information leakage upto five
days before (t - 5) the profit warning announcement, then during the two-day
announcement period (t – 1) and ( t ) there is a significant further decline in share price,
followed by a further decline for upto seven days (t + 7) after the announcement. This
implies that the effects of the profit announcement were not instantaneous and hence any
study relating to the profit announcement must be conducted over the entire period of at
least thirteen days for which the share price has been found to be affected by the
announcement.4
Jackson and Madura() found no evidence of significant reversal of the share price after
the four day post-announcemnt period5.
2.2.3. Profit warnings and Information Transfers
Besides the fact that many studies confirm the relationship between profit warnings and
negative revaluation of the announcing firm, it is also expected that investors use
information contained in firm specific and industry specific information to revaluate
competing companies in the same industry as the announcing firm.
If a firm issues a profit warning whose underlying cause is firm specific, the effects of
the warning may only be limited to the announcing firm. An alternative argument as
posed by Lang and Schultz () is that the bad news announced by one firm may create
opportunities for rival firms in the same industry6. A positive reaction in the share prices
of non-announcing firms to a negative announcement by a firm in that industry is called
3
Jackson and Madura confirmed that profit warnings are associated with a negative revaluation of the firm.
They found that in the US firms that issued profit warnings had an average decline in share price of 17.1%
over a four-day pre-warning period and over the two-day announcement period).
4
Jackson and Madura found that the average abnormal returns were negative at the 0.1%
level for days: (t – 3) and (t - 2) – In the pre warning period
(t + 1) and (t + 4) – In the post warning period
5
Jackson and Madura’s study found that there was a a general underreaction on the announcement date, hence
the further decline in share prices upto seven days after the announcement. They found that the Cummulative
abnormal return from day (t + 11) to day (t + 60) was 1.49% and that it is statistically significant. Thus the
unusually strong negative share price response to profit warnings does not appear to represent an overreaction.
6
Such competitive effects have been tested and detected for specific types of bankruptcy events by
Lang and Stulz() and for specific types of dividend reductions by Laux, Starks, and Yoon().
the competitive effect. According to Lang and Stulz (), the competitive effect is the
change in the value of competitors that can be attributable to wealth redistribution.
Tawatnuntachai and D’Mello () found that the competitive effect is more pronounced in
industries with imperfect competition, where the announcement of an event reveals
comparative information about other firms in the industry.7
If on the other hand a firm issues a profit warning whose underlying cause is not only
firm specific, but rather includes industry-wide factors the bad news effects may spill
over into other firms in the industry.8 Tawatnuntachai and D’Mello () found that
contagion and competitive effects are not mutually exclusive, and thus the observed
stock price reaction is the sum of the two effects. They found that a significant negative
change in non-announcing firms’ stock prices indicates that profit warning
announcements convey negative industry-wide information. Studies have confirmed that
profit warnings do result in negative industry effects – albeit to different degrees, but as
Jin () notes no previous studies distinguished between industry-wide factors from firm
specific factors. In Jin’s view the combining of these two types of factors may lead to an
erroneous picture regarding intra-industry information transfer effects and hence any
conclusions drawn from such studies would be flawed.
7
A competitive effect could, for example occur where there is a drop in production efficiency for the
announcing firm resulting in higher marginal costs and hence higher prices or lower profit for that firm. In this
case, demand for competitors’ products could increase because their products would be substitutes for the now
more expensive products of the announcing firm.
8
Known as contagion
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Chapter 3: Hypotheses Development

The content and effects of profit warnings on the industry are dependent on the degree of
asymmetric information within that industry, as well as to how firm specific events will affect
the industry as a whole. To the extent that profit warnings provide valuable information
regarding the industry, there are several issues that need to be examined.
3.1. Market Reaction to Profit Warnings

When management issues a profit warning it is presumably doing so because it believes that
the information is important in order to reduce asymmetric distribution of information
between investors and insiders. Management does so because they believe that the
information may lead to material movements of the reference price of the listed securities. A
profit warning indicating that profits will fall short of previously expected levels is an
announcement with negative implications from the investor’s perspective and thus it is
expected that a profit warning will result in a negative market response. This leads to the
following hypothesis:
H1: Firms that make profit warning announcements will experience negative revaluations
of their share prices at the time of the announcement.
The nature of the profit warning may be due to a firm-specific event, or it may be due to
industry wide factors that would affect most firms in the industry. Firms whose
management does not disclose the industry wide effects on profits through the use of profit
warnings may experience negative valuation effects through what is known as the
contagion effect.9 This contagion effect appears because firms that operate as direct
competitors in the same industry will have strong correlation in the value of their
investments; as such the warning announcement conveys bad news about non-announcing
firms as well as the announcing firm. Based on the expected contagion effect, the
following hypothesis was posed:
H2: Non announcing firms experience negative revaluations of their share prices as a
reaction to profit warnings that convey industry wide information.
The third hypothesis that was developed, due to previously composed contradicting
reports concerning the intra-industry effects on non-announcing firms’ stock prices.
Hertzel () finds that firm initiated announcements of stock repurchases have negligible
effects on industry rivals, while Tawatnuntachai and D’Mello (), Lang and Sultz () and
9
The contagion effect implies that If the underlying conditions reflect industry-wide factors, the effects of the
warning may spill over to industry rivals.
P a g e | 13
Baginski () all find evidence of contagion and/or competition effects on non-announcing

firms followed by firm specific announcements by announcing firms. In order to confirm
the presence and effects of intra-industry effects of profit warnings in South Africa the
following hypothesis was tested:
H3: Non-announcing firms do not respond to announcements of profit warnings that

convey firm specific information only.
3.2. Factors That May Influence the Effects of Profit Warnings on the Industry
Past research indicates that there may be a number of factors that could affect the impact
that profit warnings have on the industry.
3.2.1. General Market Reaction to the Profit Warning Announcement
If a new profit warning reveals information that is previously unknown to the market and
the information is industry wide, there should be an effect on all competing firms in that
industry. Firth () argues that when an announcement contains a strong element of
surprise, the relatively large abnormal return for the announcing firm is likely to be
mirrored, to a lesser extent, in the magnitude of the abnormal returns for industry-related
firms. Thus the following hypothesis is postulated:
H4: There exists a positive relationship between the average cumulative abnormal returns of
non-announcing firms and the average cumulative abnormal returns of announcing
firms.
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3.2.2. The Size of Firm That Issues the Announcement
“The size of the announcing firm could be an indication of the level of influence, power,
and leadership of this company in the industry” (). As noted by Kohers in the previous
statement the size of the firm could be a significant factor that will affect how
announcements issued by that firm will be “taken” by the market. Thus the argument is
that a profit warning issued by a relatively large firm may be more likely to send
industry-wide signals which negatively affect other firms that regard the announcing firm
as an important industry leader.10 This leads to the following hypothesis:
H5:There exists a negative relationship between the average cumulative abnormal returns
of the non-announcing firms and the size of the announcing firm.
3.2.3. Degree of Industry Homogeneity
Most studies relating to intra-industry information transfers indicate that industries which
are characterized by a high degree of homogeneity are more likely to exhibit intra-
industry information transfers to a larger extent.11 This implies that in an industry
comprised of firms that are relatively similar, a profit warning announcement by one firm
may result in a greater overall industry reaction.12 The higher the degree of industry
homogeneity, the more positively correlated the returns of the announcing firm would be
with those of the other firms in the industry, thus strengthening the information transfer.
Hypothesis 6 therefore tests whether industry homogeneity has an effect on the
cumulative abnormal returns of non-announcing firms in the industry.
H6:There is a negative relation between the average cumulative abnormal returns of the
non-announcing firms and the degree of industry homogeneity.
___________________________________________________________________________
10
It is expected that the larger the announcing firm, the more negative reaction of the non-announcing firms will
be.
11
Studies such as: Kohers (1999); Tawatnutntachai and D’Mello (2002) and Baginski (1987) all noted this
phenomenon
12
This is because the factors which give rise to the announcement of the profit warning will affect other
firms in the homogeneous industry and thus there will be a more significant negative reaction in the non-
\announcing firms than there would have been in a less homogenous industry.
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P a g e | 16
Chapter 4: Sample Data and Methodology

This section of the report deals with how the sample data was obtained, as well as with the
methodology that was applied in testing the hypotheses that were developed in chapter 3.
4.1. Sample Data

The sample data consists of well publicised profit warning announcements. The sample of
profit warnings, as well as the daily stock price information was obtained from McGregor
BFA and DataStream. The dataset includes profit warnings made by JSE listed firms
between May 1999 and February 2004. All disclosures with implications for annual
earnings will be included, not only quantitative statements, but also qualitative statements,
as they convey the direction of earnings changes to investors.
4.1.1. Profit Warning Classification
The profit warnings will be classified as either containing firm specific information or
industry-wide common information based on the reasons provided for in the profit
warning document.13
4.1.2. Data Selection Criteria - Filters
All well publicised profit warnings were considered, but those with the following
properties were excluded: Simultaneous announcements (within the industry) and
announcements made within two days of each other are excluded to ensure that the profit
warning of the announcing firm is the only factor driving the observed market reactions
around the warning announcement.
13
See appendix A - The Appendix provides the basis on which profit warnings were classified and examples
of the actual announcements.
P a g e | 16
Sample Data and Methodology P a g e | 20
Additionally, to narrow the focus on the share price response to profit warnings, we
exclude announcements mentioning several events, such as:
• Announcements that provide half year earnings along with a warning about future
earnings are removed from the sample.
• Announcements that include other information, such as dividend announcements
are removed, as the market reaction could not be fully attributable to the warning
announcement itself.
• Firms are excluded from the dataset for the presence of confounding events, such
as share repurchase announcements or acquisition announcements within a two
day window of the profit warning.
• The Diversified Financials industry has also been excluded since we do not
expect a strong information transfer effect to occur in this industry.
• Announcing firms that do not trade on the day of a profit warning have also been
excluded from the sample since we do not expect there to be an information
transfer if the announcing firm does not react to its own profit warning.
4.2. Event Study 14

In order to identify the stock price response of the announcing firm to the announcement of
a profit warning and to capture informative announcements, the event study methodology
will be used to estimate daily abnormal returns for the 11 day window (t - 5, t + 5) to test
hypothesis 1. The event day (day t) is the date of the profit warning announcement. The
event window was assumed to consist of 250 days. Profit warnings by other firms in the
same industry around the warning announcement (days t - 2 to t + 2) will be excluded to
ensure that the profit warning of the announcing firm rather than profit warnings of the
other firms is driving the observed market reactions around the warning announcement. The
index model is used to estimate abnormal returns.
14
Formulas used to conduct the event study were obtained from “Investments” By Bodie, Kane and Marcus,
Sixth Edition.
The index model parameters are estimated using ordinary least squares method in the
following model:
Rit = αi + βi Rmt + εit

(1)
Where:
• Rit is the return for stock i in time t,
• Rmt is the market return during the period t measured by the All Share Index,
• αi is the average rate of return the stock would realise in the period with a zero
market return,
• βi is the coefficient of volatility of stock i’s return in relation to the market return,
• εit is the regression residuals.
Normal returns are then calculated as follows:
E(Rit) = αi + βiRmt (2)

Where:
• E(Rit) is the expected return on stock i in time t,
• αi and βi are the parameters of the market model,
• Rmt is the market return in time t measured by the All Share Index.
To estimate the effects of the profit warning on the warning firm’s returns, abnormal returns
are estimated as follows:
A(Rit) = Rit –E(Rit) (3)

Where:
• A(Rit) is the abnormal stock return for stock i at time t,
Average abnormal returns for each day and cumulative abnormal returns are estimated over
the event period and a t-test is used to verify whether mean and cumulative abnormal
returns are statistically significant or not.
AARt =
1 n
 ARit
n i 1
(4)
ACARx,y =
y
 AAR
tx
t
(5)
Where:
• AARt is the average abnormal return at time t,
• CARxy is the average cumulative abnormal return from time x to time y.
To compute the effect on the reference share price of a profit warning on the announcing
firm’s competitors, average abnormal returns will be estimated for a random sample of
firms in the industry for the event window. A minimum of two competing firms and a
maximum of ten competing firms will be selected for each profit warning released by the
announcing firm.15. The above analysis will be conducted for each classification of profit
warning, firm specific and industry-wide in order to test hypotheses 2 and 3.
4.3. Cross-Sectional Regression Analysis

A cross-sectional regression is employed to more comprehensively examine the variables
that influence the industry effects of profit warnings and to provide evidence of hypotheses
4 through 6. The two-day (days t to t + 1) cumulative abnormal returns to non-announcing
firms are regressed against measures of: the market reaction of the announcing firm, the size
of the warning firm, the degree of competition and the control variables such as growth of
the announcing firm and market sentiment. We control for a firm’s growth prospects, since
a profit warning may reflect a more severe signal to a high growth industry. 16 We also
control for market sentiment at the time of each profit warning since a profit warning may
15
If there are not at least three competing firms in the industry, the effects of profit warning will not be
considered. Companies have been divided into industries according to the industry they are listed in on the JSE.
16
The announcing firm’s growth (measured by the earnings-price ratio (EPR)) is used as a proxy for industry
growth.
reflect a more severe signal in declining markets. The non-announcing firms’ negative
market reactions in rising markets may be attenuated since investors could believe that the
industry outlook as a whole is positive and that future period’s profits will rise.
The following model is estimated to examine the variables that influence the industry
effects of profit warnings:
CAR = α + β1CARA + β2SIZE + β3HOMO + β4GROWTH + β5SENTIMENT + ε (6)
Where:
• CAR is the two-day (days 0 to +1) cumulative abnormal return for the non-
announcing firms;
• CARA is the two-day (days 0 to +1) cumulative abnormal return for the firm
announcing the profit warning;
• SIZE is the size of the firm issuing the profit warning (measured by the natural log
of the market value of equity) on day t - 20 (relative to the profit warning);
• HOMO is a dummy variable which takes the value of 1 one for homogeneous
industries (e.g. Banking, Energy and Utilities industries) and 0 otherwise. Where
homogeneous industries are industries that are similar in terms of the product or
service offering or the general operating environment. 17
• GROWTH is a measure of growth of the announcing firm and is a proxy for the
growth of the industry and is measured using the earnings-price ratio (higher
earnings-price ratio implies lower growth);
• SENTIMENT is an indicator of market sentiment. It is a measure of the underlying
feeling in the market during the 20 day period prior to the profit warning and is
measured by the holding period return on the JSE All Shares Index;
• ε is the regression error term.
__________________________________________________________________________
17
Specifically, the Banking and Utility industries are characterised as homogeneous, because of the regulatory
constraints which greatly limit the ability to diversify. The Energy industry is characterised as
homogeneous due to the relatively standardised products and services with little differentiation potential.
Chapter 5: Descriptive Statistics

The subsequent section is to be used as a summary of the data that has been collected during
this study. It includes a breakdown of the types of profit warnings that were issued in various
industries as well as the various correlations that were conducted.
5.1. Characteristics of Profit Warnings

After applying the filters as discussed in section 4.1.2 to the 124 profit warnings that were
recorded over the study period the final sample consists of 51 profit warnings as shown in
Table 1: Profit Warnings. This is a substantial reduction in the size of the sample data, but if
the filters were not included the results of the study would have not been a true
representation of intra-industry information transfers, which this report aims to investigate.18
Table 1: Profit Warnings segmented by source of warning
1999 2000 2001 2002 2003 Total

Sample by source of warning
Total Sample 12 23 9 4 3 51
Industry-Wide 3 7 1 0 2 13
Firm Specific 9 16 8 4 1 38
Additional information is shown in Table 2 which contains a frequency distribution of the

announcing and non-announcing firms corresponding to each profit warning observation in
the sample on an industry basis. A total of 28 industries are represented. The distribution
suggests substantial dispersion in the industries of profit warning firms. No single industry
accounts for more than 9.09% of the sample observations and only six industries contribute
more than 5% of the observations in the sample. The least represented industries are; Banks,
Buildings and Construction materials, Chemicals, Diamond, Electrical Equipment, Farming
and Fishing, Food and Drug Retailers, Investment Companies, Other Construction and
Publishing and Printing as well as the various retailers with just one profit warning each in
the final sample.19 As noted above, the minimum number of competitors is two non-
announcing firms and the maximum is ten non-announcing firms. The mean number of
18
One should also note that it was found that relative to other stock markets there is a lower disclosure record of
profit warnings in South Africa – For the same period a total of 246 profit warnings were available on ASX
listed companies, this however does not indicate poor disclosure practices on the part of South Africa. This
may be explained by different economic conditions in the two counties.
19
This may be attributed to the narrow classification of industries that was employed, but this has been deemed
necessary in order to ensure that only strict competitors’ returns within the same industry are compared.
competitors per profit warning is 4.53 and the median is 4.50. There are a total of 231 non-
announcing firms and Table 2 shows that the sample is well diversified.
Descriptive Statistics P a g e | 24
Table 2: Frequency Distribution of industries for announcing and non-announcing firms
No. of Announcing Percentage of Total Average No. of Rival Firms per Total No. of Percentage of Total
Industry Firms Announcing Firms Announcement Rival Firms Rival Firms
Auto Parts 2 3.64% 2 3 1.30%
Banks 1 1.82% 8 8 3.46%
Building & Construction Materials 1 1.82% 10 10 4.33%
Business Support Services 3 5.45% 3 10 4.33%
Chemicals – Speciality 1 1.82% 5 5 2.16%
Computer Services 4 7.27% 4 15 6.49%
Containers & Packaging 1* 5.45% 4 4 1.73%
Diamond 1 1.82% 10 10 4.33%
Diversified Industrials 2 9.09% 3 6 2.60%
Electrical Equipment 1* 1.82% 8 8 3.46%
Electronic Equipment 2 3.64% 3 5 2.16%
Engineering – General 3 5.45% 2 5 2.16%
Farming & Fishing 1 1.82% 10 10 4.33%
Food & Drug Retailers 1 1.82% 4 4 1.73%
Gold Mining 2 3.64% 9 17 7.36%
Insurance - Non-Life 2 3.64% 2 3 1.30%
Investment Banks 4 7.27% 3 12 5.19%
Investment Companies 1 1.82% 10 10 4.33%
Metals & Minerals 2 3.64% 9 18 7.79%
Other Construction 1 1.82% 10 10 4.33%
Other Financial 4 7.27% 2 7 3.03%
Publishing & Printing 1 1.82% 5 5 2.16%
Real Estate Holdings & Development 2 3.64% 10 20 8.66%
Restaurants and Pubs 2 3.64% 2 3 1.30%
No. of Announcing Percentage of Total Average No. of Rival Firms per Total No. of Percentage of Total
Industry Firms Announcing Firms Announcement Rival Firms Rival Firms
Retailers – Hardlines 1 1.82% 4 4 1.73%
Retailers - Multi Department 2 3.64% 3 6 2.60%
Retailers - Soft Goods 1 1.82% 8 8 3.46%
Shipping & Ports 1 1.82% 5 5 2.16%
Total: 28 defined industries 51 100% 4.53 231 100%
* indicates situations where there was more than one profit warning – in these cases the second profit warning and the issuing firm were
excluded from the study, but there were enough non-announcing competitors to allow the initial profit warning to be considered.
Tables 3, 4, and 5 provide the Pearson correlations between the Average Cumulative
Abnormal Return (ACAR) for announcing and non-announcing firms from day t = 0 and
day t = +1. For the full sample, average cumulative abnormal returns for announcing firms
are negative (at -7.97%) and those for portfolios of non-announcing firms are also negative
(albeit to a lesser degree of -0.10%). For the industry-wide sub sample, average cumulative
abnormal returns for announcing firms are negative (-8.49%) and those for non-announcing
firms are also negative (-0.33%). For the firm specific sub sample, average cumulative
abnormal returns for announcing firms are negative (at -7.80%) and those of non-
announcing firms are slightly negative (-0.02%). This suggests that the profit warnings
included in the sample tend, on average, to convey bad news not only for the announcing
firms, but also for non-announcing firms (at varying degrees depending on the type of
announcement).
The Pearson correlation coefficient between ACAR (0 to +1) for announcing firms and
ACAR (0 to +1) for non-announcing firms is positive (0.123) and significant at the 0.01
level for the full sample. For the industry-wide sub sample, the Pearson correlation between
ACAR (0 to +1) for announcing and non-announcing firms is positive (0.344) and
significant at the 0.01 level. For the firm specific sub sample, the Pearson correlation
between ACAR (0 to +1) for announcing and non-announcing firms is small and positive (at
0.048), but not significant. These correlations provide preliminary evidence of an
association between announcing firms’ ACAR and the stock returns of competitors in the
same industry for profit warnings conveying industry-wide information (as expected) and
for the full sample, but not for firm specific announcements. Furthermore, Table 6 shows
that the difference between the two correlation coefficients is significant at the 0.01 level (z-
score = 1.608)20.
20
Z-statistic testing was applied because despite only having 13 values for the industry specific sub-
sample, it has been determined in Appendix B that the daily returns of the full sample follows a normal
distribution, hence any sample drawn from this population can be tested by the z-statistic.
Table 3: Summary Statistics and Pearson correlations - Full Sample
ACAR (0 to +1) ACAR (0 to +1)

Announcing Non-Announcing
Full Sample Summary Statistics
Mean (%) -7.97% -0.10%
Standard Deviation 0.161 0.134
N 51 51
Pearson Correlation
Announcing ACAR 0 to +1 1 0.123
Significance (2-tailed) 0.015
Table 4: Summary Statistics and Pearson Correlations - Industry Wide Sub-sample

I.W. Sub-Sample Summary Statistics
Mean (%) -8.49% -0.33%
N 13 13
Pearson Correlation
Table 5: Summary Statistics and Pearson Correlations – Firm Specific Sub-sample

F.S. Sub-Sample Summary Statistics
Mean (%) -7.80% -0.02%
N 38 38
Pearson Correlation
Table 6: Test of Significance between Correlation Coefficients of ACAR for Announcing and
Non-Announcing Firms21
Correlation Coefficient Between

Announcing and Non-Announcing N
Firms' ACAR (0 to +1)
Industry-Wide Sub Sample (R1) 0.344 13
Firm Specific Sub Sample (R2) 0.048 38
R1 - R 2 0.296
z-score 1.608
Table 7 shows accounting ratios for companies making profit warnings segmented by
industry. Return on Equity (ROE) is a key indication of the company’s performance as it
provides information on how well managers are employing funds invested by the
shareholders to generate returns. The positive earnings per share (EPS) and ROE ratios
indicate good recent performance for the companies making profit warnings. The EPS for
the Banking is the highest at 332.12 cents/share and the ROE for the Food and Drug
Retailers is the highest at 43.30%. The average market sentiment of 0.123 % suggests that
the overall outlook prior the announcement of the profit warnings was positive
21
This table yields the result of a test of the hypothesis that the two correlation coefficients obtained from the
relationship between the average cumulative abnormal return (0 to +1) for the announcing firms and
non-announcing firms are equal between the industry-wide and firm-specific sub samples.
Table 7: Accounting Ratios for Companies making Profit Warnings
Average Average Average

Average Average
Industry MCAP EPS Sentiment
PER ROE
(ZAR m) (cents) *
Auto Parts 484.86 5.78 11.90 239.53 0.82
21296.4
Banks 1 8.04 21.45 332.12 0.78
Building & Construction
Materials 882.99 6.42 -14.75 142.00 0.22
Business Support Services 2887.04 8.91 -7.66 98.45 0.06
Chemicals - Speciality 1589.90 8.66 4.36 95.48 -0.14
Computer Services 429.33 7.07 -13.90 30.61 -0.10
Containers & Packaging 1631.48 -4.33 18.23 39.60 -0.50
Diamond 588.38 4.21 6.19 95.90 -0.10
Diversified Industrials 60.80 8.15 7.98 228.20 -0.30
Electrical Equipment 1505.46 5.19 10.44 140.94 0.09
Electronic Equipment 38.79 -3.94 -25.38 -1.35 0.02
Engineering - General 159.31 1.78 7.63 67.53 0.54
Farming & Fishing 601.65 4.35 15.00 71.90 -0.20
Food & Drug Retailers 3757.54 18.31 43.30 47.60 1.40
Gold Mining 7922.33 4.47 12.36 301.20 -0.04
Insurance - Non-Life 3943.29 18.54 15.60 263.07 0.02
Investment Banks 3047.23 5.02 23.59 196.00 -0.03
Investment Companies 131.42 0.30 -55.04 12.65 0.09
41660.5
Metals & Minerals 0 5.18 21.40 281.23 -0.09
Other Construction 1253.15 4.07 2.20 72.76 0.04
Other Financial 554.16 7.69 -76.60 12.28 -0.01
Publishing & Printing 1027.54 11.37 0.50 191.00 -0.10
Real Estate Holdings &
Development 318.71 5.96 2.00 71.08 -0.02
Restaurants and Pubs 105.76 0.65 13.30 19.73 -0.10
Retailers - Hardlines 1237.76 8.57 17.92 246.43 0.36
Retailers - Multi
Department 1826.97 7.88 21.84 23.80 1.05
Retailers - Soft Goods 716.62 10.64 1.91 2.31 -1.08
Shipping & Ports 3432.92 5.98 29.02 195.98 0.76
Average 3681.87 6.25 4.10 125.64 0.123
Note: MCAP = (Number of shares issued at end year) x (share price at year end).
PER = (Closing share price on last day of company's financial year / (Earnings per share)
ROE = (Net profit after tax before abnormal, less outside equity interests / (diluted weighted
number of shares outstanding during the year).
EPS = (Net Profits After Tax) / (shareholders equity - outside equity interests).
*
Holding period return over 20 days prior to the profit warning.
All accounting ratios are for the year end closest to the announcement of the profit warning.
Results P a g e | 46
Chapter 6: Results
This section of the report describes the results that have been obtained (from the event study
and the multivariate regression) in a graphical manner through the use of tables and graphs,
there is also a detailed explanation of the information that can been drawn from each set of
results that has been obtained.
6.1. Event Study Results – Full Sample

Table 8 presents the event study results for the full sample of profit warnings for
announcing and non-announcing firms for the period of five days before, to five days after
the announcement day. Cumulative abnormal returns are also reported in Table 8 for days
-1 to 0; 0 to +1; -1 to +1 and -2 to +2.
Table 8: Effects on Returns in Response to Profit Warning Announcements - Full Sample22
Average Abnormal Return (%)

Day Relative to
Announcing Firms Non-Announcing Firms
Announcement
-5 0.90% 1.37%
-4 0.87% 2.11%
-3 0.34% -0.42%
-2 -0.19% 1.03%
-1 -0.62% 0.07%
0 -4.89% -0.31%
1 -3.09% 0.21%
2 -1.25% -0.55%
3 -0.52% 0.31%
4 -0.21% -1.22%
5 0.22% 0.15%
Average Cumulative Abnormal Return (%)
Day Relative to
Announcement
-1 to 0 -5.51% -0.25%
0 to +1 -7.97% -0.10%
-1 to +1 -8.60% -0.04%
-2 to +2 -10.04% 0.44%
N 51 51
22
This table reports mean abnormal returns and mean cumulative abnormal returns around the announcements
of 51 profit warnings between January 1999 and December 2003. Non-announcing average abnormal returns
are the equally-weighted average abnormal returns of portfolios of other firms with the same industry
classification as announcing firms. Abnormal returns are calculated using the market model. Average
Cumulative Abnormal Return is the sum of the average abnormal returns for the days specified (-1 to 0, 0 to
+1, -1 to +1, and -2 to +2).
6.1.1. Effects on Announcing Firms – Full Sample
The largest average abnormal return for announcing firms occurs on day t = 0 (-4.89%)
followed by day t = +1 (-3.09%) and the average cumulative abnormal returns from day t
= -1 to t = +1 (-8.60%) and from day t = -2 to t = +2 (-10.04%), all of which are highly
significant with p-value = 0.00. These negative results are consistent with the expectation
that share prices in announcing firms will fall following a profit warning. These results
therefore provide support for hypothesis 1 (H1 on pg. ), which stipulated a negative
reaction in the announcing firms to the announcement of a profit warning.
On the days prior to the announcement there is presence of significant and negative
average abnormal returns which is consistent with the findings of Elayan, Meyer and Sun
(2002). There is a relatively gentle decline and a gradual increase in negative average
abnormal returns on the days before the profit warning compared to the large declines on
day t = 0 and day t = +1. This provides support for the notion that investors have
identified firms with poorer than expected earnings and have started to downgrade
market prices or there was some information leakage prior to the announcement of the
profit warnings.
There are no significant daily average abnormal returns after the two-day announcement
period (days t = 0 to t = +1) suggesting that the majority of the response to the profit
warnings occurs over this period. The significant negative reaction on the day following
the warning (-3.09%) could be the result of some market participants delaying their
trading until they observe the assessment, based on research bulletins or trading, of
informed investors.
Figure 1 overleaf, provides a visual depiction of average abnormal returns and average
cumulative abnormal returns over the event window for the full sample of announcing
firms.
Figure 1: AAR and ACAR for Full Sample of Announcing Firms23
The large negative spike in average abnormal returns on day t = 0 can clearly be seen.
Figure 1 also shows that in the days prior to the profit warning the market starts a
downward anticipatory movement. There is then a sharp drop over days t = -1 to t = 0
and a further fall from day t = 0 up to day t = +1 and thereafter a recovery as shown by
the average cumulative abnormal return trend line.
6.1.2. Effects on Non-Announcing Firms – Full Sample
The average abnormal return for non-announcing firms on day t = 0 (-0.31%) is

significant at the 5% level (p-value = 0.038). The average cumulative abnormal returns
from days t = -1 to t = +1 (-0.04%) are significant at the 1% level (p-values = 0.01)24. By
observation alone it is not clear whether the decline on day t = 0 is significant, but the p-
value for the t-test performed on the differences of returns from zero show that it is
significant at the 1% level (P-value = 0.02) These results provide evidence of an intra-
industry information transfer from firms announcing profit warnings to non-announcing
firms.
6.1.3. Full Sample Results – Summary of Findings
The contagion effect dominates the competitive effect on average which results in
negative abnormal returns for the announcement-period. Thus, the unfavourable
information conveyed by profit warning announcements has a net negative effect on the
equity value of the other firms in the industry. Therefore, the finding of previous
studies that the market revises the announcing and non-announcing firms’ values in the
same direction in the context of different corporate events also extends to profit
warnings and confirms Hypothesis 1.
23
This Figure shows the relation between Days Relative to the Profit Warning announcement (x-axis), Average
Abnormal Return (AAR) and the Average Cumulative Abnormal Return (ACAR) for the full sample of profit
warnings (N = 51) for announcing firms over the event window (t = –5 up to day t = +5).
24
p-values for t-tests of the differences of the returns from zero. p-values display the smallest level of
significance for which the hypothesis can be rejected ().
6.2. Event Study Results – Industry-Wide Sub Sample

Table 9 presents the event study results for the industry-wide information sub sample of
profit warnings for announcing and non-announcing firms for the period of five days before,
to five days after the announcement day. Cumulative abnormal returns are also reported in
Table 9 for days -1 to 0, 0 to +1, -1 to +1 and -2 to +2.
Table 9: Effects on Returns in Response to Profit Warning Announcements – Industry-Wide Sub

Sample

Day Relative to
Announcement
-5 0.32% 0.02%
-4 0.37% -0.09%
-3 0.27% -0.98%
-2 -0.74% 0.78%
-1 -1.40% -1.75%
0 -3.84% -1.66%
1 -4.64% 1.33%
2 -0.45% -1.02%
3 -0.34% -0.64%
4 -1.20% -0.88%
5 -0.24% -0.09%
Day Relative to
Announcement
-1 to 0 -5.24% -3.41%
0 to +1 -8.49% -0.33%
-1 to +1 -9.89% -2.08%
-2 to +2 -11.07% -2.31%
N 13 13
6.2.1. Effects on Announcing Firms – Industry Wide Sub Sample
(p-value = 0.00) followed by day t = 0 (-3.84%)25 (p value = 0.01). The average
cumulative abnormal returns from days t = -1 to t = +1 (-9.89%) and from days t = -2 to t
= +2 (-11.07%), both with p-value = 0.00. This shows a negative reaction in announcing
firms to the announcement of profit warnings that convey industry-wide information.
This was the expected reaction as the profit warnings convey negative implications on all
firms in the industry from the market’s perspective.
There are also significant and negative average abnormal returns on day t = -2 (-0.74%,
p-value = 0.03) and day t = -1 (-1.40%, p-value = 0.01). These negative average
abnormal returns could be attributed to some of the factors discussed previously in
section 6.1.1 or investors may have been able to predict adverse industry conditions from
alternative sources, such as from forecasts of a drought for the agriculture industry,
before a profit warning was issued.
The presence of further decline in AAR up to five days after the announcement period
suggesting that the full response to the profit warning conveying industry wide
information occurs over an extended period of time. This could be because of investors
continually re-adjusting their valuations according to how the market reacts to the news
for the industry in the days after the announcement.
As above, for the full sample, the significant negative reaction on the day following the
warning (-4.64%, p-value = 0.01) could be the result of some market participants
delaying their trading until they observe the assessment, based on research bulletins or
trading, of informed investors.
Figure 2: AAR and ACAR for Industry-Wide Sub Sample of Announcing Firms
Figure 2 provides a visual depiction of average abnormal returns and average cumulative
abnormal returns over the event window for the industry-wide information sub sample of
13 announcing firms. The large negative spike in average abnormal returns on days t = 0
and t = 1 is clearly shown. Figure 2 also shows that in the days prior to the release of the
profit warning, there is a downward anticipatory movement. There is then a sharp drop
over days t = 0 to t = 1 and a further fall from day t = 1 up to day t = +5.
25
This result was not expected, some possible explanations are examined later in this section
6.2.2. Effects on Non-Announcing Firms – Industry Wide Sub Sample
Figure 3 plots the average abnormal returns and the average cumulative abnormal returns
in non-announcing firms against the day relative to the profit warning for the industry-
wide information sub sample. At first glance there seems to be a somewhat mixed
reaction in the AAR of non announcing firms; in the pre-announcement period, there is a
significant and negative average abnormal return for non-announcing firms on day t = -3
(-0.98%), followed by a smaller but positive AAR on day t = -2 (0.78%), but which was
found to be insignificant (p-value = 0.21). By observing the trend line of the ACAR
shown in Figure 3 there is a gradual increase in the negative abnormal return up until its
maximum point of -1.75% on day t = -1 followed by a further general declining trend
similar to that of the announcing firms shown in Figure 2 26.
The significant average abnormal returns, which show a negative trend up to and after
the announcement could be explained by one of the same factors for announcing firms
prior to the announcement of a profit warning, as described in section 6.2.1 (on pg. ).
Figure 3: AAR and ACAR for Industry-Wide Sub Sample of Non-Announcing Firms
6.2.3. Industry-Wide Sub Sample Summary of Results
Table 9 shows that the average abnormal return for non-announcing firms on day t = 0 (--
1.66%) is significant at the 1% level (p-value = 0.01). The average cumulative abnormal
returns from days t = -1 to t = +1 (-2.08%) and from days t = -2 to t = +2 (-2.31%) are
also significant at the 1% level (p-values = 0.01). These results provide evidence of an
intra-industry information transfer from firms announcing profit warnings that convey
industry-wide information to non-announcing firms. There is a net contagion effect
resulting in a negative effect on the equity value of other firms in the industry. Thus, if
the underlying conditions that give rise to profit warnings reflect industry-wide factors,
there is a spill over effect to the rest of the industry. These results therefore provide
support for hypothesis 2 (H2) which states that there is a negative reaction in non-
announcing firms to the announcement of profit warnings that convey industry-wide
information.
26
The increase in positive AAR on day t = 1, has been evidenced but after applying the t-tests was found not to
be significant (p-value = 0.26), despite this point there is a clear negative trend over the period after the
announcement for up to days (t = 5), the AAR for days t = 3 and t = 4 have been found to be significant
using the t-tests.
6.3. Event Study Results – Firm-specific Sub Sample

Table 10 presents the event study results for the firm-specific information sub sample of
profit warnings for announcing and non-announcing firms for the period of five days before,
to five days after the announcement day. Cumulative abnormal returns are also reported in
Table 10 for days -1 to 0, 0 to +1, -1 to +1 and -2 to +2.
Table 10: Effects on Returns in Response to Profit Warning Announcements – Firm-Specific Sub
Sample

Day Relative to
Announcement
-5 1.10% 1.83%
-4 1.04% 2.87%
-3 0.36% -0.22%
-2 -0.01% 1.11%
-1 -0.36% 0.69%
0 -5.24% 0.15%
1 -2.56% -0.17%
2 -1.53% -0.39%
3 -0.58% 0.64%
4 0.13% -1.34%
5 0.38% -0.29%
Day Relative to
Announcement
-1 to 0 -5.60% 0.83%
0 to +1 -7.80% -0.02%
-1 to +1 -8.16% 0.66%
-2 to +2 -9.69% 1.39%
N 38 38
6.3.1. Effects on Announcing Firms – Firm-Specific Sub Sample
followed by day t = +1 (-2.56%), both highly significant with p-values of 0.00. The
average cumulative abnormal returns from days t = -1 to t = +1 (-8.16%) and from days t
= -2 to t = +2 (-9.69%) are also significant with p-values of 0.00. Thus, there is a
negative reaction in announcing firms to the announcement of profit warnings that
convey firm specific information. It is interesting to note that the maximum negative
average abnormal return for firm specific announcements (-5.24% on day t = 0) is greater
than that of industry-wide announcements (-4.64% on day t = 1). However, this
difference is not statistically significant (p-value = 0.271). Thus, there is no differential

reaction to industry-wide announcements and firm specific announcements for the firms
making the announcement.
There are significant and negative average abnormal returns on the days prior to the
announcement of the profit warnings suggesting either an information leakage prior to
the announcement of the profit warnings or investors may have identified firms that have
specific problems before the release of the profit warnings and downgraded market
prices before day t = 0.
There is a positive and significant average abnormal return on day t = + 4 (0.13%, p-

value = 0.03), possibly suggesting a small correction to over-reaction to the profit
warning. After this correction there are gradual adjustments in the equity value until the
stock price reaches its true equilibrium value. Figure 4 provides a visual depiction of
average abnormal returns and average cumulative abnormal returns over the event
window.
Figure 4: AAR and ACAR for Firm-Specific Sub Sample of Announcing Firms
The large negative spike in average abnormal returns on day t = 0 is clearly shown.
Figure 4 also shows that in the days prior to the release of the profit warning (days t = -2
and t = -1), there is a downward anticipatory movement. There is then a sharp drop on
day t = 0 followed by further decline up to day t = +3 thereafter a recovery as shown by
the average cumulative abnormal return trend line.
6.3.2. Effects on Non-Announcing Firms – Firm-Specific Sub Sample
Figure 5shows the relation between days relative to the profit warning (x-axis) and
average abnormal return (y-axis) for the firm specific sub sample of profit warnings (N =
38) for non-announcing firms over the event window (day –5 to day +5).
Figure 5: AAR for Firm-Specific Sub Sample of Non-Announcing Firms
The daily ACAR have not been included in the figure due to the findings which implied
that there are no significant average abnormal returns for non-announcing firms over the
entire event window. The average abnormal return on day t = 0 and the average
cumulative abnormal return over the periods t = -1 to t = +1 and t = -2 to t = +2 are
statistically insignificant.
6.3.3. Firm-Specific Sub Sample Summary of Results
The results for this section suggest that profit warnings containing firm specific
information have no significant effect on their industry rivals and hence imply that there
is no evidence of either a contagion or competitive intra-industry effect. These results
provide support for hypothesis 3 (H3 on pg. ) which stated that non-announcing firms do
not respond to the announcement of profit warnings that convey only firm specific
information. By inspection of Figure 5 it can be seen that there is no clear finding of
abnormal returns around the announcement day for non-announcing firms in the firm
specific sub sample, which is confirmed by tests for statistical significance27.
6.4. Multivariate Cross-Sectional Analysis – Full Sample

Five independent variables are used to explain the market reaction in non-announcing firms
to profit warnings and provide evidence on the three hypotheses previously developed. The
two day (days t = 0 to t = +1) ACAR of the non-announcing firms is the dependent variable.
Since negative Price-Earnings Ratios (PER) are not very meaningful, observations with
negative EPRs have been removed from the sample and the regression has been run with
only positive EPRs in the model28. The regression results for the sample are shown in Table
11.
Table 11: Cross-Sectional Multivariate Model Results - Full Sample
Variable Value p-value

Intercept 0.1223 0.3280
ACARA 0.0835 0.0792
LNMVE -0.0141 0.4905
HOMO 0.0215 0.5976
SENTIMENT 0.2633 0.3320
EPR -0.0021 0.0938
Regression Summary Statistics
R-Squared 0.0582
Adj. R-Squared 0.0420
F-statistic 3.4809
N 50
27
This observation has been backed up by statistical tests. i.e. Determining the p-values for t-tests of the
differences of the average abnormal returns from zero
28
A negative PER implies that investors will be given money to buy a company's earnings, which is not the
case.
Table 11 provides the parameter estimates of the independent variables The Model is
significant at the 1% level (F-statistic = 3.4809).
6.4.1. Coefficient - ACARA – Full Sample
The coefficient for the average cumulative abnormal return for announcing firms
(ACARA) is positive and significant at the 10% level in the Model (p-value = 0.0792).
This conforms to our expectations and provides support for hypothesis 4 (H4 on pg. ) for
the full sample of profit warnings. The β1 coefficients are less than one, indicating that
stock price reactions of non-announcers will be less than the abnormal return of the
profit warning firms.
6.4.2. Coefficient – LNMVE – Full Sample
The coefficient for the natural log of the size of the announcing firm (LNMVE) is
negative but insignificant. This is contrary to our expectations and indicates that the size
of the announcing firm is not a determinant of the stock price reaction of non-
announcing firms for the full sample of profit warnings. Thus hypothesis 5 (H5 on pg. )
is not supported for the full sample of profit warnings.
6.4.3. Coefficient - HOMO – Full Sample
The coefficient for the homogeneous industry (HOMO) which is a dummy variable that
takes the value of one for homogeneous industries29 (e.g. Banking, Energy and Utilities
industries), has been found to be positive but insignificant. Thus, hypothesis 6 (H6 on pg.
) is not supported for the full sample of profit warnings.
6.4.4. Coefficient - SENTIMENT – Full Sample
The coefficient for the market sentiment variable (SENTIMENT) is positive but
insignificant. This provides some evidence that the negative stock price reaction in non-
announcing firms is attenuated when the recent market sentiment has been positive.
6.4.5. Coefficient - EPR – Full Sample
The coefficient for the earnings-price ratio (EPR) is negative and significant at the 10%
level (p-value = 0.0938). Thus the EPR is a significant explanatory factor for the stock
price reaction of non-announcing firms.
29
Homogeneous industries are industries that are similar in terms of the product or service offering or
the general operating environment. Specifically, the Banking and Utility industries are characterised as
homogeneous, because of the regulatory constraints which greatly limit the ability to diversify. The
Energy industry is characterised as homogeneous due to the relatively standardised products and
services with little differentiation potential.
6.5. Multivariate Cross-Sectional Analysis – Industry Wide Sub-Sample

The same regression as the one discussed above was then carried out for the Industry Wide
Sub-Sample, and the results are summarized in the table below.
Table 12: Multivariate Cross-Sectional Analysis - Industry Wide Sub-Sample Results

Intercept 0.0563 0.3979
ACARA 0.0588 0.0247
LNMVE -0.0078 0.0952
HOMO 0.0104 0.0787
SENTIMENT -0.0058 0.5359
EPR 0.0000 0.7762
R-Squared 0.7283
Adj. R-Squared 0.5585
F-statistic 4.2894
N 13
The adjusted R-squared for the industry-wide sub sample (0.5585) is higher than that of the
full sample (0.0420) indicating that the independent variables in the models explain more of
the variation in the ACAR of the non-announcing firms for the profit warnings conveying
industry-wide information than for profit warnings conveying industry-wide and firm
specific information as in the full sample.
6.5.1. Coefficient - ACARA – Industry Wide Sub-Sample
The coefficient for the average cumulative abnormal returns for announcing firms
(ACARA) is positive and significant at the 5% level in the model (p-value = 0.0247).
This indicates that for profit warnings conveying industry-wide information there is a
negative reaction in non-announcing firms, however to a lesser extent than in the
announcing firms since the coefficient is less than one. This provides support for
hypothesis 4.
6.5.2. Coefficient - LNMVE – Industry Wide Sub-Sample
The coefficient for the natural log of the size of the announcing firm (LNMVE) is
negative and significant at the 10% level (p-value = 0.0952). This indicates that for profit
warnings that convey industry-wide information, the larger the size of the announcing
firms, the more negative is the ACAR of the non-announcing firms. This supports
hypothesis 5 for profit warnings that convey industry-wide information.
6.5.3. Coefficient - HOMO – Industry Wide Sub-Sample
The coefficient for the homogeneous industry variable (HOMO) is positive and
significant at the 10% level (p-value = 0.0787). This provides evidence that the higher
the degree of industry homogeneity, the less negative is the cumulative abnormal returns
of non-announcing firms, contrary to our expectations.
6.5.4. Coefficient - SENTIMENT – Industry Wide Sub-Sample
The coefficient for the market sentiment variable (SENTIMENT) is positive but
insignificant in the model. This provides some evidence that the negative stock price
reaction in non-announcing firms, following the announcement of a profit warning that
conveys industry-wide information, is attenuated when the recent market sentiment has
been positive.
6.5.5. Coefficient - EPR – Industry Wide Sub-Sample
The coefficient for the earnings-price ratio (EPR) is negative, but insignificant thus is not
an explanatory factor for the stock price reaction of non-announcing firms in response to
profit warnings that convey industry-wide information.
6.6. Multivariate Cross-Sectional Analysis – Firm Specific Sub-Sample

The regression models for the firm specific sub sample, presented in Table 13, are not
statistically significant (F-statistic = 0.8567). The adjusted R-squared for the Model is
negative (-0.0089) indicating a poor fit of the regression.
Table 13: Multivariate Cross-Sectional Analysis – Firm Specific Sub-Sample - Results

Intercept -0.0687 0.5051
ACARA 0.0734 0.1148
LNMVE -0.0126 0.0986
HOMO -0.0037 0.9548
SENTIMENT 0.0216 0.9370
EPR 0.0000 0.2397
R-Squared 0.0543
Adj. R-Squared -0.0089
F-statistic 0.8567
N 37
The coefficient for the natural log of the size of the announcing firm (LNMVE) is positive
and significant at the 10% level (p-value = 0.0986). This indicates that the greater the size
of the announcing firm, the smaller is the negative average cumulative abnormal return in
the non-announcing firms for profit warnings that convey firm specific information to the
market.
The remaining coefficients were found to be statistically insignificant.
__________________________________________________________________________
P a g e | 47
Chapter 7: Conclusion
This section of the report will discuss the implications of the findings as derived from the
results, followed by a discussion regarding the limitations of the study and closing with
recommendations for future studies.
7.1. Conclusions and Implications

Investors utilise publicly available information, including information provided in profit
warnings, in their decisions about capital allocation. For this reason, the J.S.E. obliges listed
companies to keep investors informed in a timely manner about material price-relevant
information. Thus the main contribution of this study lies in the answer to the question of
whether there is a difference between the share price behaviour of non-announcing firms in
response to firm specific announcements and industry-wide common announcements.
7.1.1. Conclusions Drawn From the Event Study
For profit warnings conveying industry-wide information the announcing firms and the
rivals of the announcing firms incur significant negative abnormal returns. This reaction
implies that participants of financial markets gather new information about industry
conditions for rivals as well as for announcing firms from profit warnings that are issued
due to industry-wide factors.
For profit warnings conveying firm specific information the announcing firms incur
significant negative abnormal returns, whereas, the rivals of the announcing firms do not.
The significant negative reaction shows that market participants gather new information
about the announcing firms from firm specific announcements but not for the rival firms,
shown by the insignificant average abnormal returns. This is because firm specific
factors are problems unique to a particular firm and therefore should have no effect on
rival firms.
By separately documenting the intra-industry information transfer process for the

industry-wide information and firm specific information sub-samples, this study
overcomes a shortcoming of previous studies in the area of information transfers which
lead to an inaccurate description of the intra-industry information transfer process.
The finding of significant negative abnormal returns in the days leading up to the
announcement day provides evidence of some information leakage. This is consistent
with the results of Jackson and Madura () in the U.S. In contrast Helbok and Walker()
and Collett () did not find the same in the U.K. which could suggest a lower level of
leakage in periods running up to trading updates in the U.K. than in the U.S. and South
P a g e | 47
Africa. Alternatively, investors in South Africa and the U.S. may have identified firms
with poorer than expected earnings and had started to downgrade market prices prior to
the profit warning. This could be due to investors in South Africa and the U.S. utilising
other sources of information to predict the negative effects before the profit warning is
issued.
7.1.2. Conclusions regarding Full Sample Multivariate Regression
For the full sample of profit warnings the average cumulative abnormal return of the
announcing firms was a significant contributor to the cumulative abnormal return of the
non-announcing firms. Thus, if the profit warning contains new information that affects
the whole industry the market will inflict a more negative price adjustment on all the
firms in the industry.
The positive market sentiment coefficient for the full sample of profit warnings provides
evidence that the negative stock price reaction in non-announcing firms is attenuated
when the recent market sentiment has been positive. That is, the market punishes
competing firms to a lesser extent when market sentiment is relatively favourable.
Once the negative EPRs are excluded from the cross-section regression model, the EPR
becomes a significant explanatory factor for the stock price reaction of non-announcing
firms. The negative coefficient indicates that the higher the EPR (lower industry growth),
the more negative is the stock price reaction in non-announcing firms. This could be
explained by the notion that firms that are not growing do not have the ability to expand
into areas not affected by the reasons given for the profit warning, resulting in greater
negative average cumulative abnormal returns in non-announcing firms.
The size of the announcing firms is not a significant contributor to the cumulative
abnormal return of the announcing firms for the full sample of profit warnings. Perhaps
investors did not distinguish between large and small firms that announced a profit
warning or perhaps large firms do not necessarily have more power, influence or
leadership in their respective industries.
The degree of industry homogeneity had no significant impact on the cumulative

abnormal return of the announcing firms for the full sample of profit warnings. Possibly
the homogeneous industries used in this study were not of a sufficient degree of
homogeneity.
P a g e | 47
7.1.3. Conclusions regarding Industry Wide Sub-Sample Multivariate Regression
For the industry-wide sub sample of profit warnings, the average cumulative abnormal
return of the announcing firms was a significant contributor to the cumulative abnormal
return of the non-announcing firms; the implications of this are the same as those
discussed in section 7.1.2.
The size of the announcing firm was a significant contributor to the cumulative abnormal
return of the non-announcing firms. The negative coefficient implies that for profit
warnings issued due to industry-wide factors, larger firms are seen as leaders in the
industry who have more power and influence over smaller firms.
In homogeneous industries, there is a less negative reaction in non-announcing firms to

the announcement of a profit warning. This provides evidence that, contrary to what we
expected, homogeneous industries provide an environment conducive to competitive
reactions. That is, rival firms in homogeneous industries react less negatively to profit
warnings that are issued for industry-wide reasons than do firms in less homogeneous
industries.
The growth and Sentiment of the industry were found to be insignificant contributors to
the cumulative abnormal return of the non-announcing firms for profit warnings issued
due to industry-wide factors.
P a g e | 47
7.1.4. Conclusions regarding Firm Specific Sub-Sample Multivariate Regression
For the firm specific information sub sample of profit warnings, the size of the
announcing firms was a significant contributor to the cumulative abnormal return of the
non-announcing firms. Graham and King () found that information is typically more
readily available for large firms than information about smaller firms. Therefore, the
positive coefficient for firm size of the announcing firms could imply that the
information was already available to investors in announcing firms and investors in non-
announcing firms resulting in less negative abnormal returns in non-announcing firms.
The average cumulative abnormal return of the announcing firms was not a significant
contributor to the cumulative abnormal return of the non-announcing firms. This could
be due to the nature of firm specific information, that bad news specific to the has no
inference for the non-announcing firms.
The homogeneous industry variable and the market sentiment variable are not significant
contributors to the cumulative abnormal return of the non-announcing firms. This again
could be due to the nature of firm specific information even in homogeneous industries
and in all conditions of recent market sentiment.
P a g e | 47
7.2. Limitations of the Study
The most significant limitation of this study is the scarcity with which profit warnings are
issued in South Africa. This factor resulted in a very small Industry-wide Sub-sample30 of 13
profit warnings, after the filters were applied, the results of which may need further
confirmation. Most previous studies that conducted similar tests used samples in excess of
100 announcements, however the analysis of the data generally provided results in line with
our expectations.
Although this study provides evidence of intra-industry information transfers, the negative
average and cumulative average abnormal returns detected are relatively small compared to
previous studies in the area of information transfers. A possible reason for this is due to the
limitations of the industry definitions that were applied. These limitations include the level
of aggregation at which some industries are defined and the diversification strategies
adopted by many firms. The classification may have been too specific not allowed some
competing companies’ returns to be compared, but this was done to ensure that only the
returns of direct competitors are considered. This however could have reduced the
magnitude of information transfers observed relative to those that would be observed using
alternative industry definitions.
Another limitation of this study stems from the difficulty in classifying some of the profit
warnings into their respective groups, that is, those that convey industry-wide information
and those that convey only firm specific information. In some profit warnings, the reasons
given for the warning are somewhat ambiguous which made it difficult to clearly classify
them which may have resulted in the incorrect classification of some profit warnings.
Another possible limitation is that managers may attempt to blame their expected fall in
profitability on industry-wide factors and hide firm specific problems from the market. That
is, if a company’s profit warning contains only industry-wide reasons for the warning, but
there are firm specific problems that are not mentioned, the negative reaction in the
announcing firm may be attenuated.
30
The Average Abnormal Returns were found to follow a Normal type distribution, hence even with the
small sample it was possible to apply hypothesis testing to the sample in order to evaluate the
developed hypotheses. – See Appendix B
P a g e | 47
7.3. Suggestions for Further Research
The results of this study have shown that profit warnings provide new information about
competitors in the same industry. Refinements and extensions of the study are indicated to
provide a better understanding about the information transfer effect.
One possible improvement would be to address the limitation of the industry definitions
mentioned above. For example a homogeneous line of business classification could also be
used in order to refine this study – this is the approach that has been adopted by some
previous studies on intra-industry information transfers. Firms could be grouped in terms of
end product similarity and only those firms with at least 50 percent of their revenue from
the same line of business could be included in the sample. This procedure will reduce the
amount of diversification in each industry and thus increase the ability of the test to detect
intra-industry information transfers.
Different variables could also be included in the cross-sectional regressions to investigate

what types of factors are useful in explaining the industry reactions. For example, the level
of competition within an industry could explain, in part, the effects of a firm’s profit
warning on other firms. A profit warning made by a firm in a highly competitive industry
could cause the firm’s rivals to positively re-evaluate their competitive standings within the
industry. Rival firms may then re-assess the announcing firm as a less prominent and less
threatening industry competitor. Thus, the herfindahl index, a measure of the degree of
industry concentration (lower herfindahl index implies a higher level of competition), could
be included in the regression models to provide evidence of whether the level of
competition within an industry is a significant explanatory factor of the effects of a profit
warning on other firms.
The state of the economy could impact the effects of the average abnormal returns, in that it
may be possible to note greater impact on share prices when the economy is growing
stronger. This report took this into account in the SENTIMENT variable in the multivariate
regression, but the variable only focused on a period of 20 days, perhaps a longer period is
required in order to take the effects of the economy into account, or an entirely new variable
could be introduced.
The decision of whether to disclose as well as whether to disclose accurately and fully may
be influenced by many factors. Further research may also investigate the determinants of
disclosure decisions. For example, managers rewarded with share options may have the
incentive to release bad news prior to stock option award dates, thus pushing down the price
P a g e | 47
of the option. Aboody and Kaznik () provide evidence for this practice. The threat of legal
action is also likely to have an impact on disclosure behaviour. It would be interesting to
assess this determinant of the decision to disclose bad news in South Africa and compare it to
the more litigious environment of the U.S. It is likely that the threat of litigation will have
less of an influence on managers’ behaviour in South Africa than in the U.S. but further study
needs to be performed in order to verify this.
P a g e | 61
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Aboody, D. & Kaznik, R. (2000). CEO Stock Option Awards and The Timing of Corporate Voluntary Disclosures.
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Appendix A P a g e |A.108
Appendix A: Profit Warning Classification

A.1. Characteristics of Industry-Wide and Firm Specific Profit Warnings
Table A1 broadly identifies the characteristics that have been used to classify profit warnings
into the industry-wide and firm specific groups based on the reasons stated in the
announcement released to the market.
Table A. 1 Classification of Profit Warnings into Industry-Wide and Firm Specific Groups
Firm Specific Industry-Wide
Production & Quality problems Difficult Market/Trading Conditions

Accounting Errors/Difficulties Regulation/Legislation
Litigation costs Adverse weather conditions
Delays to contracts and negotiations Sales short of forecasts
Loss of major customer
Restructuring costs
Acquisition/mergers costs
Problems with contracts and negotiations
Management and systems problems
Fraud/Theft
Repair/remedial works
A.2. Examples of Profit Warnings and their Classification
E.g. 1: On the 27th September 2000 Stella vista technologies limited released the
Following statement:
Announcement: trading statement and forecast warning

The directors of Stella vista, listed in the development capital market sector of the
Johannesburg stock exchange, take this opportunity to update shareholders on the
current trading position.
Transactions falling outside the financial year as announced on 28 July 2000 the
company received an order valued at R24 million for final delivery in December
2000. This contract, which had taken almost two year to conclude, involves the
delivery of 40 led displays for installation on service station forecourts around the
country. As at Stella vista's year-end, 31 august 2000, some R3,9 million of this
contract had been completed and invoiced. Production is currently on scheduled and
delivery will be completed by due date. In august the company received an order for
R18,5 million, for which the contract had been signed and the products completed and
through the factory acceptance test by the year-end. However, the customer has
experienced difficulty in arranging finance and, as payment has not been received in
terms of the contract, Stella vista has withheld delivery and consider that it would not
be prudent to account for the contract in the financial year ended 31 august 2000.
Should the purchaser secure the finance necessary to conclude the transaction,
shareholders will be advised and the transaction included in the current financial year.
Forecast warning
Had either of the above contracts been completed within the financial year ended 31
august 2000, the company would have exceeded forecast turnover and profit.
However, as advised above, this did not happen. Accordingly, shareholders are
advised that, while the company will achieve a profit for the year ended 31 august
2000, it will not achieve the profit as forecast in the prospectus.
Current prospects
The directors are satisfied that the company is well positioned to be successful in the
current financial year ending 31 august 2001. The company has the balance of the
forecourt display order, amounting to R20, 1 million, to complete and has secured
orders for in excess of a further R3.7 million. Total orders on hand at the end of
September 2000, the first month of the new financial year, therefore already exceed
the turnover for the previous financial year. The R18.5 million orders may or may not
be fulfilled, and the company is in the process of disposing of the inventory on hand
or using it to fulfil other orders. The development of the new generation led display
and control system will be completed during this calendar year. This should place
Stella vista in the top five companies worldwide in term of this technology. In order
for Stella vista to compete and be active in the largest market for Led displays, it has
established an office in the United States during the year. It has already exhibited
products at trade shows in Los Angeles and Florida. The international market for led
displays as supplied by Stella vista is growing faster than was initially expected and
the company expects positive results from its offshore operations in the near future.
The audited preliminary results for the financial year ended 31 august 2000 will be
released in mid-November and the financial statements distributed to shareholders
shortly after that date.
Discussion regarding example 1

This warning is firm specific as it addresses problems that are only relevant to Stella Vista
namely the two uncompleted contracts. These problems effect Stella Vista only are we do not
expect that it will affect the other companies in the industry.
E.g. 2: On the 14th March 2000 Concor limited released the following profit warning:
Profit warning
Shareholders in Concor are advised that the group will report a loss for the six months
ended 31 December 1999 despite a satisfactory performance from all core operations.
This result is below forecast and market expectations and has arisen because of
- continued losses on the Lesotho joint venture project;
- Higher than expected closure costs of the electrical division; and
- A valuation shortfall on a shopping centre in Wellington.
Agreement has been reached with our international Lesotho joint venture partners,
limiting the total loss, to the amount already provided by the group.
The group's balance sheet remains strong and the provisions created for these losses
have no immediate impact on the cash.
The interim results for the six months ended 31 December 1999 will be published on
29 March 2000.
By order of the board.
Discussion regarding example 2

The above statement has been classified as firm specific which will lead to a decrease in
profit for Concor. This classification is due to firm specific problems given: continued losses
on the Lesotho joint venture project, higher than expected closure costs of the electrical
division and a valuation shortfall on a shopping centre in Wellington. As such it is not
expected that these factors will convey any information about other firms in the industry.
E.g.3. On the 16th July 1999 Woolworths holdings limited released the following statement:
Statement regarding profit

The difficult economic conditions in the segment of the retail market in which the
group's South African business, Woolworths, operates, together with a very mild
winter, has impacted negatively on the profitability of Woolworths.
We wish to confirm to shareholders the market expectation that headline earnings per
share (HEPS) for the year ended 30 June 1999 will be lower than those for the
comparable period last year. Further details will be announced with the release of the
results for the year ended 30 June 1999 on 19 august 1999 and later when the annual
financial statements are issued.
Plans presently being implemented are expected to result in an improvement in
trading performance in the forthcoming year.
Discussion Regarding Example 3:

The above profit warning has been classified as conveying industry-wide information in that
the information it conveys is relevant to all companies in the retail industry. As such the
difficult economic conditions and the mild winter will have a negative effect for all
companies in the retail industry.
P a g e |B.114
Appendix B: Distribution of Average Abnormal Returns

The following figures serve as evidence of Normal-like distributions of returns that have been
recorded for 5 days prior to and five days after the Profit warning announcement is made.
They show the distributions of abnormal returns for each day, for the full population of
announcing firms (N = 54).
Since the Full Population of announcing Firms exhibits a normal-like distribution of returns
on each of the individual days, it is possible for one to apply t-statistic testing for significance
on samples of the population even when the sample contains less than 30 values ().
Please note – Frequency distributions of days t = -5, t = -1, t = 0, t = 1 and t = 5 are the only
ones displayed in this appendix (in order to avoid unnecessary information), but all of the
days exhibit the same general shape of frequency distribution.

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Table 3: Summary Statistics and Pearson correlations - Full Sample......................................26

Chapter 2: Literature Review

2.1. Information transfers

2.2. Profit Warnings

2.2.1. Management’s Incentives to Disclose information

2.2.2. Market Reaction to Profit Warnings

2.2.3. Profit warnings and Information Transfers

Chapter 3: Hypotheses Development

3.1. Market Reaction to Profit Warnings

Baginski () all find evidence of contagion and/or competition effects on non-announcing

H3: Non-announcing firms do not respond to announcements of profit warnings that

3.2.1. General Market Reaction to the Profit Warning Announcement

3.2.2. The Size of Firm That Issues the Announcement

3.2.3. Degree of Industry Homogeneity

Chapter 4: Sample Data and Methodology

4.1. Sample Data

4.1.1. Profit Warning Classification

4.1.2. Data Selection Criteria - Filters

4.2. Event Study 14

Rit = αi + βi Rmt + εit

Normal returns are then calculated as follows:

E(Rit) = αi + βiRmt (2)

A(Rit) = Rit –E(Rit) (3)

4.3. Cross-Sectional Regression Analysis

CAR = α + β1CARA + β2SIZE + β3HOMO + β4GROWTH + β5SENTIMENT + ε (6)

Chapter 5: Descriptive Statistics

5.1. Characteristics of Profit Warnings

Table 1: Profit Warnings segmented by source of warning

1999 2000 2001 2002 2003 Total

Additional information is shown in Table 2 which contains a frequency distribution of the

Table 2: Frequency Distribution of industries for announcing and non-announcing firms

Table 3: Summary Statistics and Pearson correlations - Full Sample

ACAR (0 to +1) ACAR (0 to +1)

Table 4: Summary Statistics and Pearson Correlations - Industry Wide Sub-sample

ACAR (0 to +1) ACAR (0 to +1)

Table 5: Summary Statistics and Pearson Correlations – Firm Specific Sub-sample

ACAR (0 to +1) ACAR (0 to +1)

Correlation Coefficient Between

Table 7: Accounting Ratios for Companies making Profit Warnings

Average Average Average

6.1. Event Study Results – Full Sample

Table 8: Effects on Returns in Response to Profit Warning Announcements - Full Sample22

Average Abnormal Return (%)

6.1.1. Effects on Announcing Firms – Full Sample

Figure 1: AAR and ACAR for Full Sample of Announcing Firms23

6.1.2. Effects on Non-Announcing Firms – Full Sample

The average abnormal return for non-announcing firms on day t = 0 (-0.31%) is

6.1.3. Full Sample Results – Summary of Findings

6.2. Event Study Results – Industry-Wide Sub Sample

Table 9: Effects on Returns in Response to Profit Warning Announcements – Industry-Wide Sub

Average Abnormal Return (%)

6.2.1. Effects on Announcing Firms – Industry Wide Sub Sample

6.2.2. Effects on Non-Announcing Firms – Industry Wide Sub Sample

6.2.3. Industry-Wide Sub Sample Summary of Results

6.3. Event Study Results – Firm-specific Sub Sample

Average Abnormal Return (%)

6.3.1. Effects on Announcing Firms – Firm-Specific Sub Sample

difference is not statistically significant (p-value = 0.271). Thus, there is no differential

There is a positive and significant average abnormal return on day t = + 4 (0.13%, p-

6.3.2. Effects on Non-Announcing Firms – Firm-Specific Sub Sample

Figure 5: AAR for Firm-Specific Sub Sample of Non-Announcing Firms

6.3.3. Firm-Specific Sub Sample Summary of Results

6.4. Multivariate Cross-Sectional Analysis – Full Sample