Abstract
This study extends prior research attempting to identify factors influencing the return-earnings relation. It examines all firm-specific characteristics known to significantly influence the relation between earnings and return to reduce the likelihood of an omitted variable problem. More importantly, the study uses the recursive partitioning technique to avoid the subjectivity in specifying the earnings response regression model and the problems resulting from the OLS regression assumptions. The recursive partitioning analysis indicates that five factors—exchange listing, incidence of loss, earnings predictability, earnings persistence and book value per share—affect the return- earnings relation. When included in the earnings response regression, these factors explain a large percentage of the cross-sectional variations in return. Sensitivity tests are performed for alternate return windows and measure of unexpected earnings.
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