The Effect of Profit Warning Announcements on the Share Returns of Firms Listed at the Nairobi Securities Exchange

Abstract

Profit warning announcement forms an integral part of mandatory disclosures that are set up by the regulatory bodies. The capital markets have evidenced immerse growth and innovations that have led to more stringent measures being put in place to prevent insider trading and fraud cases. The disclosure of the profit warning aims to ensure transparency and information asymmetry in the securities market. When there is material expected negative deviation of profits compared to the previous period firms have an obligation to inform the shareholders and the public at large. The profit warning announcements have being associated with a negative market reaction and huge abnormal returns. This study examines the effect of profit warning announcements on the share returns at the NSE. The report is based on the 64 companies listed at the NSE and 16 sampled firms drawn from companies that have issued profit warnings for the period 2015 to 2016. The research design used was the event study using the market model which assessed the impact of announcements on the returns. The event window is twenty one days (-10,+10) and an estimation period of 30days. The CAPM model was used to estimate the expected returns. The CAR during the period amounted to -7.24%. The AR and CAR were plotted on a graph and there was a downward trend after the announcements showing the negative market reaction. The mean of the abnormal returns was -1.21% while the standard deviation was 4.80% the day after the event. The CAR mean was 3.83% and the standard deviation was at 18.17% the day following the announcement. The regression analysis indicated that the independent variable which is the market return can only explain and predict shares return during profit warning announcements by 6.72%. The study concludes that profit warning announcement has a negative impact on the shares return at the NSE. This is evidenced by the negative abnormal returns realized and the test of significance using F statistic which is at 0.94.The study recommends firms to give more details in the profit warnings in order to inform the shareholders on the causes of the deviations in earnings. Further, the study recommends that regulatory bodies should put more stringent measures to avoid insider trading and ensure that there is no leakage of information. Further areas of study include the factors influencing the issue of profit warnings by firms and measures taken by firms to reduce earning deviations in the subsequent years.