Investigating the Determinants of Earning Response Coefficient: A Case Study of PSX’s KSE-100 Index

Abstract

The purpose of this study was to determine what factors affect the Earnings Response Coefficient (ERC) for the 30 companies that have been listed on the Karachi Stock Exchange's 100 stock index (KSE-100) during the years 2019-2022. This was achieved by evaluating the company's profitability, its debt percentage, and the extent to which the firm is affected by market-wide movements (i.e., systematic risk), as it relates to investors' responses to earnings announcements. Secondary data were used for the study, which included audited financial statements, annual reports, and other publicly available financial data sources. Descriptive statistical analysis and pooled ordinary least squares (OLS) regression, along with diagnostic tools such as variance inflation factor (VIF) diagnostics, normality tests, and heteroscedasticity corrected estimations, were utilized to ensure the reliability of the findings. The results indicated that the mean ERC value is 0.025. In essence, investors respond to earnings announcements in the Pakistani equity market at a rate much lower than investors in developed countries. Return on assets (ROA), a measure of profitability, has a positive and statistically significant relationship with ERC, indicating that investor responses to earnings announcements are greater when firms exhibit strong operating performance. Leverage (measured using the debt-to-equity ratio), and systematic risk (measured using beta), are both negatively associated with ERC, suggesting that high levels of financial risk and/or market volatility reduce investor confidence in reported earnings. Overall, the explanatory variables explain approximately 36 percent of the variability in ERC. This study adds to the limited body of research examining earnings informativeness in developing capital markets, provides empirical evidence from Pakistan, and highlights the importance of prudent capital structure decisions, effective risk management, and improved financial reporting disclosure practices to increase investor responsiveness to earnings announcements.