Seasonal affective disorder and investors' response to profit warnings

Abstract

A listed company must publish a profit warning if its profit or financial position differs substantially from its expected profit or financial position. I examine how seasonal affective disorder (SAD) affects investors’ response to profit warnings. SAD is a medical condition that is characterized by a depressed mood during times when the amount of daylight is low.

The first part of the research examines abnormal returns caused by profit warnings. I find evidence that both positive and negative profit warnings generate significant abnormal returns on the announcement day. Moreover, investors have more difficulties to evaluate negative profit warnings than positive profit warnings. The results imply that the size, MB ratio, or analyst recommendations do not affect investors’ response. However, I find differences in how investors respond to positive or negative profit warnings. Specifically, the risk of the company affects immediate response to negative profit warnings whereas the number of previous profit warnings affects post-earnings-announcement drift (PEAD) of positive profit warnings.

As the main interest of this thesis, I find that SAD affects investors’ response to profit warnings. The immediate response to positive profit warnings is lower during the SAD season, which supports the hypothesis about heightened risk aversion. Moreover, the PEAD of negative profit warnings is higher during the SAD season, which also supports the SAD hypothesis. My results imply that these effects are mainly driven by the fall. Interestingly, I find that SAD does not affect the immediate response to negative profit warnings or PEAD of positive profit warnings. I suggest that these two findings are explained by the ostrich effect and negativity bias, respectively.