Persistence Of Abnormal Earnings Research Articles

Conservatism in residual income models: theory and supporting evidence

In this paper, we develop a framework for evaluating the impact of conservative accounting on the structure of residual income models of equity valuation. We explore specific examples of both unconditional and conditional conservatism and observe a common mathematical structure. We proceed to generalise our model and identify the joint dependency of conservatism and the persistence of abnormal earnings on the weights attached to book values, earnings and dividends. We are able to show theoretically the likely numerical impact of conservatism on price-earnings ratios and under-valuations produced by residual income models. We investigate empirically the interaction between conservatism and persistence and find they accord well with the theory developed. We briefly discuss the implications of testing the effect of conservatism on valuation and linear information dynamics.

Abnormal Earnings Persistence in the Jordanian Context

This paper tested the abnormal earnings persistence in the Jordanian context through Ohlson’s (1995) first Linear Information Dynamics (LID) Model using an unbalanced panel regression analysis for a sample of (840) public firms listed in the Amman Security Exchange during the period 2007 to 2011. The results showed a highly value relevance for the industrial, financial and services sectors indicated by the coefficient of the abnormal earnings persistence. The services sector had the highest value relevance. However, the industrial and the financial sectors were closed. Finally, the results for the detailed industry analysis of the sub-sectors had shown different values for the coefficient of the abnormal earnings persistence, and bank firms, printing & packaging firms, and the utilities & communication firms had the highest values for the coefficient of the abnormal earnings persistence.

The Pricing of Intellectual Capital in the IT Industry

This study adopts Ohlson's (1995) valuation model and Dechow et al.'s (1999) framework to examine the value relevance of intellectual capital (IC) disclosed by Taiwan's information technology (IT) companies. Following prior studies, we focus on four IC components: human, innovation, process, and relation. Several important findings are documented. First, Taiwan's IT companies are more likely to focus on human and process capital than on innovation and relation capital. Second, there is a positive association between IT companies' abnormal accounting rates of return and the persistence of abnormal earnings. A possible reason underlying this result is that these companies have substantial increase in sales over years. Third, IC disclosure is value relevant to IT companies' business valuation. More importantly, IC captures a large portion of the unexpected earnings. Finally, the use of a constant discount rate may be inappropriate in estimating the Ohlson model because it generates biased abnormal earnings that masks or dilutes the value relevance of IC during the business valuation process. Management and policy implications are discussed.

Valuation, Linear Information Dynamic, and Stochastic Discount Rates

We generalize Ohlson (1995) to stochastic interest rates. Our analysis provides four insights. First, the earnings capitalization multiple depends on the lagged rate, not the current rate. Second, the abnormal earnings persistence parameter increases in the current rate and decreases in the lagged rate. Third, it is not necessary to specify the stochastic process underlying interest rates to relate stock prices and accounting numbers. Finally, only the lagged rate is needed to capitalize current earnings to determine current stock price, while both the lagged and current rates are needed to forecast next-period earnings based on current earnings.

Relationship between abnormal earnings persistence, industry structure, and market share in Brazilian public firms

In this study, Ohlson's Linear Information Dynamic (LID) is analyzed and the effect of other information on the abnormal earnings series is evaluated. The hypothesis that industry structure and market share have significant effects on abnormal earnings in the following period is tested, with Ohlson's LID persistence maintained. The results confirm the premise of LID in a sample of Brazilian public firms, considering all the statistical models. The hypothesis regarding market share is rejected as its effect on the degree of abnormal earnings persistence has no informational content, either directly or jointly. Finally, the results confirm that different industries affect abnormal earnings persistence differently. In view of these results, the research hypotheses are partially rejected. It is concluded that (a) industry contains other information that can impact abnormal earnings for the following period and (b) market share (in isolation and together with industry concentration) does not imply differentiated impacts on firms' abnormal earnings for the following period, and therefore do not reflect the presence of other information in Ohlson's Model (1995).

Relationship between Abnormal Earnings Persistence, Industry Structure, and Market Share in Brazilian Public Firms

This study analyzes Ohlson's Linear Information Dynamic (LID) and evaluates the effect of other information on the abnormal earnings series. It is tested the hypotheses that industry structure and market share have significant effects on abnormal earnings of the following period, with Ohlson's LID persistence maintained. The results confirm the premise of LID in a sample of Brazilian public firms, considering all the statistical models; the hypothesis regarding market share is rejected as its effect on the degree of abnormal earnings persistence has no informational content, either directly or jointly; finally, the results confirm that different industries differently affect abnormal earnings persistence. In view of these results, the research hypotheses are partially rejected. It is concluded that (i) industry contains other information that can impact abnormal earnings of the following period and (ii) market share (in isolation and together with industry concentration) does not imply differentiated impacts on firms' abnormal earnings of the following period; they do not reflect, therefore, the presence of other information in the Ohlson's Model (1995).

An empirical assessment of the Feltham-Ohlson models considering the sign of abnormal earnings

This paper provides an empirical assessment of the Feltham-Ohlson models, distinguishing between firms with positive and negative abnormal earnings. Abnormal earnings persistence and conservatism parameters differ for these two groups; this implies different earnings prediction models and valuation functions for both profit-making and loss-making firms. The analysis refers to the period 1991-1999 and uses a sample of Spanish firms quoted on the Madrid S.E. The results suggest that our contextual approach is more useful than the non-contextual one to predict future abnormal earnings and explain current prices. Although the Ohlson (1995) model is accurate in forecasting future abnormal earnings and stock prices, the results improve when firms with negative abnormal earnings are valued using a temporary model and firms with positive abnormal earnings using a more permanent one. The Feltham and Ohlson (1995) model generates the lowest forecast errors in the prediction of positive abnormal earnings, but it produces the least accurate results in forecasting prices.

Effect of R&D investments on persistence of abnormal earnings

PurposeThis paper sets out to test the effects of firms’ and industry's R&D intensity on persistence of abnormal earnings.Design/methodology/approachOhlson's valuation model is used with pooled regressions along with Fama–Macbeth methodology on yearly regressions and partitioning on Herfindahl index to conduct the tests.FindingsIt was found that firms’ and industries’ R&D intensities are both positively correlated with persistence of abnormal earnings. The evidence suggests that the positive effect on earnings persistence caused by R&D's effectiveness in mitigating competition dominates the negative effect brought by more risk from R&D projectsPractical implicationsThe fact that the firm's own R&D investment leads to incremental earnings persistence beyond that of the industry suggests the importance of incorporating both industry and firm's R&D intensity in earnings persistence. While industry R&D investment leads to competition mitigation via creation of entry barriers, a firm's own investment in R&D differentiates its products from those of its competitors, and thereby results in further competition mitigation by creating replacement barriers.Originality/valueFinally, since R&D intensity is correlated with earnings persistence, inclusion of R&D intensity in future earnings persistence studies may lead to better model specification by reducing the problem of correlated omitted variables.

The persistence of abnormal earnings and systematic risk

Since the recent economic crisis in Korea and the opening of the Merge & Acquisition (M&A) market, the accounting information provided by hotel firms has acquired greater importance. The capital cost of hotel firms is high compared to other industries as the number of hotels listed in the securities market are very few. The purpose of this paper is to examine the relationship between the persistence of abnormal earnings and systematic risk in hotel firms. For this end, this study developed prediction models of systematic risk for hotel firms. The persistence of abnormal earnings has a systematic relation with book value of equity and earnings. In this study, persistence was measured using the first auto-correlation coefficient of abnormal earnings for two consecutive periods. The results of this study can be used to measure the persistence of growth of hotel firms and soundness of hotel management, and provide useful information for stakeholders in hotel firms. The results of this study indicate that there was a statistically significant relationship between persistence of abnormal earnings and systematic risk in hotel firms. Furthermore, the persistence of abnormal earnings was significantly related to non-accounting variables, indicating the importance of external factors for the profitability of hotel firms.

The economic value of the R&D intangible asset

This study utilizes firm-specific time-series data to estimate the economic value of the research and development (R&D) expenditures that investors consider an asset to the firm. The study uses a modification of the Ohlson (1995) model to estimate the persistence of abnormal earnings, the proportion of current R&D expenditures that represents a source of future benefits to the firm and the amortization rate of that asset. The parameters are estimated from time-series data of market and book values of equity, earnings and R&D expenditures. The study further compares the firm-specific estimates with those resulting from an application of a cross-sectional estimation procedure based on all available companies in the sample and industry-specific sub-samples. Results indicate the existence of significant differences in some two-digit SIC code industries between the time-series and the cross-sectional estimates of the parameters and the economic value of the R&D asset. Differences in the capitalization parameter are associated with the growth in R&D, the profitability of the firm, R&D intensity and the concentration of the industry. Differences in the persistence of earnings are related to the concentration ratio. Finally, differences in the estimated economic value of the R&D asset are associated with the profitability of the company as measured by its return on assets. We further compare the associations between the three different estimates of the R&D asset and subsequent stock returns, as well as the contemporaneous difference between the market and book value of companies. Results indicate that the time-series estimates of the R&D asset show stronger associations with both variables, followed by the intra-industry and the cross-industry cross-sectional estimates. Overall, our results provide evidence that market participants behave as if R&D expenditures have significant future economic benefits to the firm, and show that the cross-sectional and time-series approaches followed when assessing its economic value provide significantly different estimates.

The relationship between persistence of abnormal earnings and usefulness of accounting information in hotel companies

This study examines whether persistence of abnormal earnings affects book value of equity and earnings. According to Ohlson (Contemporary Accounting Res. (1995) 661–687) theoretical framework, a company's market value is a function of its book value of equity, earnings and other information. The persistence of abnormal earnings has a systematic relation with book value of equity and earnings. The persistence is measured using the first auto-correlation coefficient of abnormal earnings for two consecutive periods. This study intends to measure the persistence of abnormal earnings during 1993–2000 period for hotels and manufacturing companies. The results indicate that the persistence of abnormal earnings is higher for hotels than manufacturing companies and for hotels of first class than of other classes.

Individual-Firm Style Loadings, Unrecorded Economic Assets, and Systematic Risk

This study estimates individual-firm style loadings for classification of individual securities into growth (glamour) and value groups. Style loadings are similar to betas, measuring the comovement of a firm's return with the return on a particular style index. The study examines this classification by comparing the extent of unrecorded economic assets for growth and value firms. The study also examines the systematic-risk characteristics associated with this classification. Using Ohlson's (1995) valuation model, this study estimates the persistence of abnormal earnings for individual firms using time-series analysis. Growth firms are shown to have higher levels of abnormal earnings persistence than value firms, probably due to their greater levels of unrecorded economic assets than value firms. Indeed, the study finds that growth firms have greater levels of R&D and advertising intensity than value firms. The study also shows that growth and value firms differ in their systematic risk. Possibly due to the greater uncertainty associated with unrecorded economic assets, the systematic risks of growth firms are larger than those of value firms.