Abstract
This paper attempts to identify the firm specific factors that explain cross-sectional variations in the magnitude of the earnings response coefficient (ERC). Since past research shows that ERC also varies over time, a two-stage regression analysis is used. In the first stage, we estimate the ERC of each firm, allowing for the temporal variations in ERC. In the second stage, using a recursive partitioning technique, we regress the estimated ERCs on various firm specific factors to understand the nature of cross-sectional variation in ERC. We find that the cross-sectional variation in ERC is mostly explained by earnings predictability (variability), earnings level (controlling for the sign and size of earnings news), default risk, size, systematic risk, and growth. Our finding is consistent with firm valuation, political cost, and contracting cost hypotheses.
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