Optimal Financial Reporting and Equity Returns: Evidence from Commercial Banks

Abstract

This study develops a hypothesis from asset pricing theory and optimization theory that in a diversified portfolio of equity securities there is no linear relationship between equilibrium equity returns and financial reporting variables subject to managerial discretion, only a nonlinear relationship. Alternatively stated, this study presents theory and evidence suggesting that linear conditional mean effects of discretionary financial reporting variables on equity returns for an industry portfolio of firms are zero, while the nonlinear conditional mean effects are nonzero.