Effect of Profit Warning Announcements on Share Returns at Nairobi Securities Exchange

Abstract

Investors require different pieces of information when making investment decisions. Profit warning is an example of such information. In Kenya, disclosure of profit warnings to the public by companies listed at the NSE is mandatory and is enforced by CMA. The objective of this study was to examine the effect of profit warning announcements on the share returns of companies listed at the NSE. Share price data of 40 listed companies which had issued profit warnings between January 2015 and June 2018 was used. This study adopted the event study methodology where an event window was taken to be 21 days, -10 days prior the event date, +10 days post the event date and the actual date the announcement was made taken as day 0. An estimation period of 20 days was chosen. The market model was used to determine the abnormal return for each company. The expected return was calculated using OLS, NASI taken as the market proxy and data analysed using excel and SPSS application and presented in form of tables and graphs. To determine the effect on the NSE, an average abnormal return (AAR) was calculated by getting an average of the abnormal returns for all companies on every particular day over the event period and cumulative average abnormal returns (CAAR) were then calculated by summing up the average abnormal returns over the event window. Paired sample analysis was done to compare the AAR before the announcement to AAR after the announcement. The same was done for CAAR. Findings revealed positive average abnormal returns which peaked at 1.65% prior to the announcement on day -3, showing evidence of insider trading. Negative average abnormal returns of -2.19% were recorded on day +1 affirming the assertion that profit warnings are interpreted as negative information by many investors. These were statistically significant at 5% significance level with a t statistic value of +2.2334 on day -3 and value of -2.6301 on day +1. The same trend was registered for CAAR with positive returns registered prior the announcement and a reversal to negative returns after the announcement. The findings from the paired sample analysis were consistent with those of AAR. The results revealed a mean positive AAR prior the announcement of + 0.1043% and a mean negative AAR after the announcement of -0.2551%.The paired sample t- test for AAR had a t statistic value of -1.218 which is in absolute value greater than zero hence revealing that AAR before and AAR after profit warning announcement are statistically different at 95% confidence level. The mean value of the CAAR after the announcement was negative at -2.7807% while that from before the announcement was positive at +0.8427% and had t statistic value of -16.387. The conclusion drawn therefore was that the NSE is a semi strong efficient market where profit warning announcements are absorbed quickly by the market as negative news with cases of positive average abnormal returns noted prior to the announcement revealing existence of insider trading. The latter would be seen to mirror the strong form EMH but the fact that the information is only to a few of the investors and not the whole market makes it is not so. These findings better inform its users on the negative effect that profit warnings announcement have on share returns in Kenya. Companies will therefore be in a position to package these announcements in a way that the information relayed is more comprehensive on the issues leading to such announcements as well as the future prospects of the company. The regulatory authority can also enforce policies in terms of investor protection where penalties are charged where cases of insider trading are noted. Other scholars can explore the same topic using a multifactor model to incorporate other factors affecting the market at the same time as when the announcements are made.