Comparing with the average: Reference points and market reactions to above-average earnings surprises

We examine whether the average earnings surprises announced yesterday affect investors’ responses to earnings news announced today. We find that in the short window surrounding an earnings announcement, the market rewards today's earnings news that is above yesterday's average earnings surprises with a premium, consistent with yesterday's average becoming a reference point for investors to classify today's earnings news as a gain or a loss. The price premium for an above-average earnings surprise is larger when more earnings announcements are made on the same day and when investors face greater uncertainty in assessing firms’ performance. We interpret this evidence as suggesting that investors rely more on the average as a reference point when they are more likely to be subject to cognitive constraints in processing information. We also find that firms announcing above-average earnings surprises exhibit a greater abnormal trading volume, consistent with the notion that beating reference points prompts investors to trade.