Research Journal of Finance and Accounting www.iiste.org ISSN 2222-1697 (Paper) ISSN 2222-2847 (Online) Vol.4, No.16, 2013 148 Do Earnings Announcement Have an Effect on the Level of Efficiency of The Nairobi Securities Exchange? Grace Kakiya 1 , Robert Mugo 2* , Samuel Onyuma 3 , Dr. George Owuor 4 , and Mary Bosire 5 1. Finance department, Karatina university 2. School of Business, Kabarak University * E-mail of the corresponding author: mugorobert@gmail.com 3. Department of Business Management and Economics, Laikipia University 4. Department of Agribusiness Management, Egerton University 5. Department of Accounting Finance And Management Science, Egerton University Abstract Capital markets are normally considered to be efficient when prices reflect all the available information. However, there are instances when this information takes several weeks to be incorporated into share prices. This leads to investors’ making uninformed investment strategies on whether to hold or dispose shares thus unable to maximize returns. The study determined stock returns of firms listed in NSE and further determined the level of efficiency of NSE. An empirical evidence of anomalies for the study was obtained from 31 companies listed at the Nairobi Securities Exchange, which traded and announced their earnings in 2007. A data collection sheet was used to collect secondary data on market indices, daily closing share prices and traded volumes for a period of 15 days before and after earnings announcement. Daily market adjusted abnormal and cumulative abnormal returns were computed and a further t-test at 5% level of significance done to determine the effect of earnings announcement on stock returns and results interpreted. Earnings announcement had a significant effect on stock returns when CAR was evaluated indicating market inefficiency but AR was not significant for individual companies. From the findings of the study, it was concluded that the Nairobi Securities Exchange is not semi-strong form efficient. Therefore, the Capital Markets Authority should eliminate the factors causing market inefficiencies, in order to boost-to-boost investors’ confidence. Key words: Efficient Market Hypothesis, Abnormal Returns, Cumulative Abnormal Returns, and Nairobi Securities Exchange 1.0: INTRODUCTION Capital markets are reported to be efficient when stock prices fully reflect all known information about the firms. Stock prices react and often continue to move in the same direction after a firm has made earnings announcement. A short term drift occurs when stock price movement related to the earnings announcement continue long after the announcement date as observed by Rendleman et al (1987).According to Jaffe et al. (2002), there are three kinds of reaction in share price to new information in efficient and inefficient markets. The efficient market response is that prices instantaneously adjust to and fully reflect new information. Secondly, there could be a delayed response; the prices adjust slowly to the new information. Lastly, there can be an overreaction; the prices over adjust to the new information and thus a bubble in price sequence. Efficient Market Hypothesis (EMH) advocates that prices should immediately adjust to reflect new information off loaded in the market. If prices continue to move more than investors would normally expect in a positive (negative) direction after an initial positive (negative) reaction to earnings announcement news Borjesson (2007). This is termed as an under reaction or momentum effect. Borjesson denotes that if the stock prices move in a positive (negative) direction more than investors would normally expect after an initial negative (positive) reaction to the earnings announcement news, this is termed as an overreaction or reversal. There are instances where business dailies have reported an abnormal reaction in a firm’s share price on announcement of company’s earnings. Investors who keenly observe the market will earn positive rates of returns on shares because of arbitrage opportunities. This makes the stock market inefficient, which is contrary to the efficient market hypothesis. 1.1 Statement of the Problem Efficient market hypothesis dictates that in ideal situations, the market is efficient and share prices reflect all information including the surprise earnings announcements made by firms. In practice, there are cases where share prices have partially reflected the earnings information on the earnings announcement date. Investors find themselves in a state of dilemma on whether to hold the stocks and benefit from the long-run returns, or to trade the stocks by either buying or selling them depending on the nature of information released to the public. There being little conclusive empirical evidence done for the Kenyan stock market, that is, companies listed on Nairobi Securities Exchange (NSE), this study is an attempt to close the existing gaps by providing further insights on the best investment strategies to be adopted by investors. 1.2 Objectives 1. To determine the effect of earnings announcement on stock returns