The Effect of Profit Warning Announcement on the Share Prices of Companies Listed in Nairobi Securities Exchange

Abstract

Profit warning is among the most material market information where investors are required to be informed even before making their investment decisions. In the last five years, different companies have been issuing profit warnings in Nairobi Securities Exchange highlighting poor performance. The objective of this study was, therefore, to determine the relationship between profit warning and share prices of companies listed in Nairobi Securities Exchange. This study used descriptive design and an event study methodology. The population comprised of all the 68 listed companies in Nairobi Securities Exchange. The sample size of the study was 28 companies that have issued profit warnings in the last five years (2012-2016). Through the event study methodology, the study identified the event (profit warning), calendar date of the event (profit warning announcement date), events window and estimation period. The study used statistical methods to compute the abnormal returns after which the results were analyzed to obtain the Cumulative Abnormal Returns. T-test statistic was used to measure the statistical significance of the abnormal returns, cumulative abnormal returns and standardized cumulative abnormal returns. The study results indicated that there were high negative and significant abnormal returns and cumulative abnormal returns after profit warning announcements. The study also found that the market takes too long to recover from the effect of profit warning announcements on share prices. The abnormal returns on day one, second day, third day, fourth day, fifth day, sixth day and seventh day were highly negative and statistically significant. The study established that one day before profit warning announcement, the abnormal returns were significant. This shows the possibility of insider trading or leakage of information before the profit warning announcement. The study concludes that profit warning announcements have a negative effect on share prices in companies listed in Nairobi Securities Exchange. This study recommends that the Capital Market Authority should come up with policies to prevent insider trading in Nairobi Securities Exchange. Due to the negative effect of profit warning announcements on share prices, firms may shy away from making complete disclosure of their profits through profit warnings. This is due to the fear that the share market and investors will react negatively to information on profit warning announcements. In addition, firms that have issued more than one profit warnings in the last five years should seek to identify factors affecting their performance and develop strategies to ensure improvement of performance. This will help in ensuring that there are no frequent abnormal returns in their firms.