Future Earnings Expectations and Earnings Attributes

Abstract

We study how earnings attributes affect investors expectations about future earnings reflected in market prices. We separate the current earnings contribution to the formation of future earnings expectations through a fictitious valuation incorporating expectations informed only by current values of earnings. Its pricing error measures the extent to which future earnings expectations are constructed on information other than realized earnings. We investigate the association between this pricing error and eleven earnings quality constructs commonly used in the empirical literature measuring earnings volatility and predictability, cash flow and accruals smoothness, earnings smoothness relative to cash flow, accruals quality, relative conservatism and frequency of reporting special items. For a large sample of US non-financial firms over the period 1971-2014, we find that, although significant in individual analyses, most of the quality constructs are not relevant to expectation formation. The exceptions are the earnings smoothness and (to a lesser extent) the frequency of reporting special items.