Costly Information Processing

Costly Information Processing: Evidence from Earnings Announcements∗

Joseph Engelberg¥

January 10, 2008

Abstract: I examine the role of information processing costs on post earnings announcement drift. I distinguish between hard information —quantitative information that is more easily processed — and soft information which has higher processing costs. I find that qualitative earnings information has additional predictability for asset prices beyond the predictability in quantitative information. I also find that qualitative information has greater predictability for returns at longer horizons, suggesting that frictions in information processing generate price drift. Using a tool from natural language processing called typed dependency parsing, I demonstrate that qualitative information relating to positive fundamentals and future performance is the most difficult information to process.

Key words: post earnings announcement drift, underreaction, information processing, financial media

I have benefited from discussions with Torben Andersen, Nick Barberis, Paul Gao, Zhiguo He, Andrew Hertzberg, Ravi Jagannathan, Jiro Kondo, Robert Korajczyk , David Matsa, Jonathan Parker, Jared Williams and Beverley Walther. I am indebted to Mitchell Petersen and Paola Sapienza for advice and support. I also thank the Zell Center for Risk Research for its financial support. All errors are my own. ¥ Kellogg School of Management, Northwestern University, 2001 Sheridan Road, Evanston, IL 60208. Email: jengelberg@northwestern.edu.

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Electronic copy available at: http://ssrn.com/abstract=1107998

One of the most puzzling—and robust—challenges to the market efficiency hypothesis is the evidence that security prices underreact to public news. Researchers have found evidence of underreaction to earnings announcements (Ball and Brown (1968), Bernard and Thomas (1989, 1990)), share repurchases (Ikenberry et al. (1995)), dividend initiations and omissions (Michaely et...