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The Influence of Timely Reviews on the Credibility of Quarterly Earnings

The Securities and Exchange Commission (SEC) requires registrants to report interim financial information with their quarterly filings. This information need not be audited, but must be reviewed either quarterly (a timely review) or as part of the year-end audit (a retrospective review). The earlier auditor involvement required by timely reviews is believed to impart greater credibility to interim financial information; the Treadway Commission (1987) and the Whitehead-Millstein Committee (1999) both recommend that timely reviews be the required alternative. Retrospectively-reviewed interim earnings are believed to be less credible because the lack of interim-period auditor involvement permits opportunistic reporting by management. Credibility for those retrospectively-reviewed interim reports is, therefore, delayed until the year-end audit where 'settling-up' adjustments are recorded. We predict and provide evidence that the difference in credibility across timely- and retrospective-reviews results in returns being more highly associated (1) with changes in earnings for the interim periods when the review is timely and (2) with earnings levels for the fourth quarter, when the review is retrospective. The evidence also indicates that the influence of review type on the association between returns and quarterly earnings differs based on whether the earnings news is good or bad and whether it confirms or contradicts prior quarter's earnings changes.