Aggregate Earnings Changes Research Articles

Is the asymmetric impact of aggregate revenue and aggregate earnings on the stock index in accordance with the prospect theory?

AbstractThis study examines the asymmetric impact on the US S&P 500 stock index due to the changes in aggregate revenue and aggregate earnings of the index constituents. We applied the nonlinear autoregressive distributed lag model of Shin et al. (Festschrift in honor of Peter Schmidt, 2014, Springer, 281–314) to determine the long run and the short run asymmetries. The presence of a cointegrating relationship confirms that despite short‐run departures, the relationship remains stable in the long run. The nonlinear autoregressive distributed lag model estimates that when aggregate revenue increases by $1,000, the S&P index is expected to increase by 8.64 points, but when the aggregate revenue decreases by the same amount, the market decreases by 31.4 points. Similarly, when the aggregate income increases by $1,000, the S&P index is likely to increase by 22.59 points, whereas if the aggregate income decreases by the same amount, the index would decrease more steeply by 32.11 points. Based on these findings, the present study establishes an asymmetric relationship between two important accounting variables. The study also confirms the validation of prospect theory in the S&P index valuation of its constituent stocks' financial performance. Aside from using the model on aggregate data for the S&P index, we also analyzed 28 individual US stocks to validate the findings.

Aggregate Tone and Gross Domestic Product

We examine whether earnings announcement textual tone, aggregated across individual publicly traded firms, helps to predict future GDP growth. Prior literature shows changes in aggregate accounting earnings are useful in predicting future economic growth, but only when aggregate earnings changes are negative. Because conservative accounting rules limit managers’ ability to communicate positive news in a timely manner, we look to corporate narrative tone as a possible source of timely positive information disseminated by publicly traded firms. Our results show that aggregate tone is useful in predicting future economic growth, but only when the change in aggregate tone is positive. Our study contributes to prior literature by providing initial evidence on the link between qualitative accounting disclosure, accounting timeliness, and macroeconomic outcomes.

Negative accounting earnings and gross domestic product

Konchitchki and Patatoukas Journal of Accounting and Economics 57 (1-2), 76–88, (2014a) show that aggregate accounting earnings growth predicts future nominal gross domestic product (GDP) growth and that professional macro forecasters do not fully incorporate the information contained in aggregate accounting earnings. Based on results from prior literature, which find that accounting earnings reflect bad economic news in a timelier manner than good news, we condition Konchitchki and Patatoukas’s GDP growth forecast model on the sign of earnings changes. We show that negative changes in aggregate earnings predict future GDP growth while positive changes in earnings do not. Furthermore, we show that professional macro forecasters underreact to the information contained in negative changes in aggregate earnings about future GDP growth. Additional tests suggest our findings are a result of conservative accruals in earnings.

Investor Protection, Aggregate Accounting Earnings and Forecasts of Growth in GDP: International Evidence.

This study draws on the investor protection literature to examine differences in a country’s information environment that are likely to explain cross country variation in the extent to which macroeconomic forecasters take account of current earnings when forecasting future growth in GDP. Using a unique sample of analysts’ GDP forecasts from thirty countries, we find that economies with stronger levels of disclosure and enforcement regulation have a lower association between changes in aggregate earnings and errors in forecasts of GDP growth. The results are consistent with macroeconomic forecasters in countries with stronger investor protections taking greater account of changes in aggregate earnings when forecasting growth in GDP than analysts in countries with lower levels of investor protection.

On the Expected Earnings Hypothesis Explanation of the Aggregate Returns–Earnings Association Puzzle

We provide strong support for the underappreciated expected earnings hypothesis of a negative correlation between aggregate stock returns and earnings. For 1970–2000, our powerful modeling strategy incorporating macroeconomic information reveals that aggregate returns are significantly and negatively correlated with expected aggregate earnings changes but uncorrelated with unexpected aggregate earnings changes. However, this negative correlation changes after 2000, perhaps from heightened volatility or accounting changes. We also show that underlying macroeconomic information explains the power of aggregate earnings to predict future gross domestic product growth.

On the Expected Earnings Hypothesis Explanation of the Aggregate Returns-Earnings Association Puzzle

We provide strong support for the underappreciated expected earnings hypothesis of negative correlation between aggregate stock returns and earnings (Sadka and Sadka (2009); Choi, Kalay, and Sadka (2016)). For the 1970 to 2000 period studied by Kothari, Lewellen, and Warner (2006), our powerful modeling strategy incorporating macroeconomic information reveals that aggregate returns are significantly negatively correlated with expected aggregate earnings changes but uncorrelated with unexpected aggregate earnings changes. However, this negative correlation changes after 2000, perhaps from heightened volatility or accounting changes. We also show that underlying macroeconomic information explains the power of aggregate earnings to predict future GDP growth.

Aggregate earnings and gross domestic product: International evidence

ABSTRACTRecent studies in macro accounting suggest that changes in aggregate accounting earnings can predict quarterly GDP growth in the USA. Our objective in this study is to test the robustness of the association between aggregate earnings and real GDP growth across multiple countries and for different definitions of aggregate earnings. We test whether aggregate earnings changes predict future economic growth in eight countries – Australia, Canada, China, India, Japan, South Korea, the UK, and the USA. We find positive evidence regarding the generalisability of the aggregate earnings – real GDP relation in an international context. In additional tests, we find that economic forecasters appear to underreact to aggregate earnings information. Our results show that aggregate earnings lead economic growth and forecasts of real GDP growth can be improved by incorporating aggregate earnings information. Further, we also test if negative earnings changes contain more information than positive earnings changes and find only modest evidence in favour of this hypothesis. The results are robust to alternative statistical methodology and the removal of the USA data from the sample.

The Effect of Changes in Aggregate Earnings and Discount Rate to Stock Returns: Indonesian Evidence

This study aims to analyze the effect of changes in the aggregate earnings and discount rate to stock returns quarterly. The sample in this study is financial and non-financial public company that listed on the Indonesia Stock Exchange from 2010-2016. This study uses panel data and time series regression model. Minor studies of this research also wanted to examine if there are anomalies in post-earnings announcement drift at the aggregate level. The results of this study indicate that there is a significant positive influence between earnings and stock returns on both exchanges at the level of individual companies and the aggregate. This study also shows that there are positive effects similar to earnings from the discount rate on stock returns in both the individual and aggregate level.

Aggregate Accounting Data and the Prediction of Credit Risk

A recent area of accounting research concerns the ability of changes in aggregate earnings to predict various macroeconomic fundamentals. We extend this line of research and examine whether changes in aggregate earnings convey information regarding the changes in future sovereign risk, which is considered a proxy for changes in aggregate risk. The results of the study indicate that aggregate earnings changes have predictive ability for sovereign credit risk. This result persists even after controlling for liquidity and indicators of macroeconomic imbalance, as well as under alternative research specifications. We also find that in some of the research specifications, future sovereign credit risk is affected by earnings management. In general, our results point towards the presence of significant information in earnings that is related to future sovereign risk.

Cyclical Trend of Aggregate Earnings and Market Risk Premium

This study investigates why aggregate earnings changes have a significantly positive relation with contemporaneous changes in market risk premium focusing on the cyclical trend of aggregate earnings. Prior Macro-Accounting studies only propose their empirical results and do not clarify a reason behind the relation. Since empirical results without background story are difficult to make implications, we aim to propose an explanation of the unrevealed relation. Assuming that aggregate earnings changes represent new information of the time trend deviation from aggregate earnings, we obtain three empirical results which explain the relation. First, aggregate earnings have cyclical trend. If aggregate earnings are larger (smaller) compared with their trend, future earnings will become smaller (larger). Second, such aggregate earnings predict higher (lower) future market volatility and market downside risks. Third, market volatility and market downside risks recognized from the time trend deviation of aggregate earnings are reflected on market risk premium. Our results suggest that the positive relation between aggregate earnings changes and changes in market risk premium comes from the newly recognized risk information in aggregate earnings. Our contribution is to the related Macro-Accounting research stream. First, this is the first study which reveals cyclical trend of aggregate earnings and downside risks in aggregate earnings information as long as we know. Our second contribution is providing a reasonable explanation for the positive relation between aggregate earnings changes and changes in market risk premium, whose mechanism has not been clarified before.

Intertemporal Variation in the News Components of Aggregate Earnings and How it Affects the Aggregate Earnings-Return Relation

Prior research documents a negative contemporaneous relation between earnings changes and stock returns at the aggregate level. We find that the aggregate earnings-returns relation turns significantly positive in recent years (1992-2013). As explanations for that shift, we test over-time shifts in the properties of firm-level earnings and the magnitude of inflation rates. To do so, we use the Bureau of Economic Analysis’ (BEA) corporate profits series as an alternative measure of aggregate earnings, because it is unaffected by changes in GAAP measurement rules and is adjusted for changes in price levels. While changes in both aggregate GAAP earnings and the BEA’s corporate profits series exhibit a significant negative (positive) relation with aggregate returns in the 1970-1991 (1992-2013) period, changes in aggregate GAAP earnings have incremental explanatory power for aggregate returns beyond the BEA’s corporate profits measure in the 1992-2013 period. Additional analysis reveals that such incremental explanatory power stems from GAAP earnings’ inclusion of non-operating items. We also find that a shift over time in inflation, as well as in the proportion of loss-making firms, contribute to inter-temporal variation in the aggregate earnings-returns relation. The effect of changes in the properties of GAAP earnings and inflation rates over time on the aggregate earnings-returns relation is new to the literature.

Earnings news, expected earnings, and aggregate stock returns

In contrast to firm-level relations, researchers have found that aggregate earnings changes and aggregate stock returns are negatively related. In this paper, we construct new measures of aggregate earnings news based on revisions in analyst forecasts. The findings suggest aggregate earnings news is positively related to contemporaneous stock returns. The results also show that aggregate stock returns are positively related to unexpected aggregate forecast errors, and negatively associated with expected aggregate earnings growth. Taken together, these findings suggest the negative relation between aggregate earnings changes and aggregate contemporaneous stock returns results from the expected component of aggregate earnings, rather than aggregate earnings surprises.

Market-Wide Cost of Capital Impacts on the Aggregate Earnings-Returns Relation: Evidence from Japan

This study aims to clarify the mechanism of the surprising earnings-returns relation observed at the aggregate level by offering evidence from Japan. Unlike firm-level evidence, recent Macro-Accounting research reports that when earnings changes and stock returns of individual firms are cross-sectionally aggregated, a significantly positive relation cannot be observed in the U.S. market. To explain this puzzling finding, Kothari et al. (2006) propose a hypothesis that negative effects of changes in the market-wide cost of capital cancel out positive effects of aggregate earnings changes on aggregate stock returns. Although this hypothesis is empirically supported in the U.S market, the validity of this hypothesis has not been sufficiently investigated in the Japanese market. Thus, we test the hypothesis and find it robustly supported in Japan. Our results show that positive effects of aggregate earnings changes on aggregate stock returns are canceled out by the effects of the market-wide cost of capital. We also find that these canceling effects stem from the market risk premium in Japan. An additional test we conduct shows that expected aggregate earnings changes and changes in the market risk premium are not negatively related. This result indirectly supports the hypothesis proposed by Kothari et al. (2006), because it undermines the competing hypothesis proposed by Sadka and Sadka (2009). These results should contribute to the related research areas, Macro-Accounting and accounting research on the cost of capital.

The Usefulness of Negative Aggregate Earnings Changes in Predicting Future Gross Domestic Product Growth

Konchitchki and Patatoukas (2014) (hereafter KP 2014) show that aggregate accounting earnings growth predicts future nominal Gross Domestic Product (GDP) growth and that professional macro forecasters do not fully incorporate the information contained in aggregate accounting earnings. Based on results from prior literature, which find that accounting earnings reflect bad economic news in a timelier manner than good news, we condition KP’s GDP growth forecast model on the sign of earnings changes. We show that negative changes in aggregate earnings predict future GDP growth up to three quarters ahead while positive changes in earnings do not. Furthermore, we show that professional macro forecasters underreact to the information contained in negative changes in aggregate earnings about future GDP growth. In additional analyses we find evidence suggesting the incremental usefulness of negative earnings changes is driven by accounting conservatism rather than other drivers of asymmetric timeliness in earnings.

The Impacts of the Market-Wide Cost of Capital on Aggregate Earnings-Returns Relation - Evidence from Japan

This study aims to clarify the mechanism of the surprising earnings-returns relation observed at the aggregate level by offering evidence from Japan. Unlike firm-level evidence, recent Macro-Accounting research reports that when earnings changes and stock returns of individual firms are cross-sectionally aggregated, a significantly positive relation cannot be observed in the U.S. market. To explain this puzzling finding, Kothari et al. (2006) propose a hypothesis that negative effects of changes in the market-wide cost of capital cancel out positive effects of aggregate earnings changes on aggregate stock returns. Although this hypothesis is empirically supported in the U.S market, the validity of this hypothesis has not been sufficiently investigated in the Japanese market. Thus, we test the hypothesis and find it robustly supported in Japan. Our results show that positive effects of aggregate earnings changes on aggregate stock returns are canceled out by the effects of the market-wide cost of capital. We also find that these canceling effects stem from the market risk premium in Japan. An additional test we conduct shows that expected aggregate earnings changes and changes in the market risk premium are not negatively related. This result indirectly supports the hypothesis proposed by Kothari et al. (2006), because it undermines the competing hypothesis proposed by Sadka and Sadka (2009). These results should contribute to the related research areas, Macro-Accounting and accounting research on the cost of capital.

Aggregate Earnings and Market Returns: International Evidence

AbstractKothari, Lewellen, and Warner (2006) document that aggregate earnings changes in the United States arenegativelyrelated to contemporaneous market returns. In this study we show that this negative aggregate earnings-returns relation is unique to the United States. In 28 non-U.S. markets, aggregate earnings changes arepositivelyassociated with contemporaneous market returns. Further evidence shows that the aggregate earnings-returns relation becomes less positive in countries with more transparent financial disclosure that helps investors forecast earnings more precisely. Our result supports Sadka and Sadka’s (2009) argument that predictability of aggregate earnings leads to the negative relation between aggregate earnings and market returns in the United States.

Aggregate Profitability Changes, Monetary Policy and Inflation

We investigate the monetary linkage between aggregate accounting profitability changes and inflation. Recent previous evidence reveals a strong relation between aggregate earnings changes and the three components of expected stock market returns (i.e., real riskless rate, expected inflation, and expected equity risk premium) further supporting the theory of aggregate earnings changes releasing discount rate news. Extending the evidence of previous literature, this paper investigates the impact of aggregate profitability changes on monetary-policy-stance measures in order to explain the relation between aggregate profitability changes and inflation growth. The paper examines simultaneously the causal relations among aggregate profitability changes, monetary policy changes and inflation growth using vector autoregressive (VAR) models. Our empirical results document that the relation between aggregate profitability changes and inflation growth is the result of a positive relation between aggregate profitability and monetary policy changes represented either by effective federal funds, federal funds premium or real federal funds rate.

Aggregate Earnings and Corporate Bond Markets

ABSTRACTI examine the previously unexplored relation between aggregate earnings changes and corporate bond market returns. I find that aggregate earnings changes have a negative relation to investment‐grade corporate bond market returns and a positive relation to high‐yield corporate bond market returns. The aggregate earnings‐returns relation is lower (i.e., less positive or more negative) for bonds with higher credit ratings and longer maturities. Further, I show that the aggregate earnings‐returns relation is driven by both the expected and the news component of aggregate earnings changes. The expected component is negatively related to expected returns, and the news component is positively related to cash flow news and changes in nominal interest rates, and negatively related to changes in default premia. My results contribute to the understanding of the role of earnings in corporate bond markets as well as the macroeconomic role of accounting information.

Detecting news in aggregate accounting earnings: implications for stock market valuation

How much news is there in aggregate accounting earnings? I provide evidence that earnings changes at the stock market level are correlated with new information about not only expected future cash flows but also discount rates. A comprehensive investigation of the link to discount rates reveals that aggregate earnings changes are tied to news about all components of the expected future stock market return, i.e., the real riskless rate, expected inflation, and the expected equity risk premium. Over the sample period studied, cash flow news and discount rate news in aggregate earnings changes covary positively and have offsetting impacts on stock market prices. As a result, stock market prices appear to be insensitive to aggregate earnings changes. The findings highlight the importance of separating cash flow news from discount rate news when evaluating the information content of accounting earnings at the stock market level. Overall, my study sheds new light on the informativeness and relevance of accounting earnings for valuation at the stock market level.

Aggregate Earnings and Market Returns: International Evidence

Kothari, Lewellen and Warner (2006) document that in the U.S. market aggregate earnings changes are negatively related to contemporaneous market returns. This is puzzling given the well-documented evidence that firm-level earnings changes are positively related to stock returns. In this study we use a sample of 28 countries to provide international evidence on this important issue. In pooled cross-country and time-series regressions, we find that aggregate earnings changes are positively associated with contemporaneous market returns. When we run time-series regressions of market returns on aggregate earnings changes for each country, we find only four countries have negative coefficients for aggregate earnings changes and none of these negative coefficients are statistically significant. This evidence contrasts the U.S. evidence. Furthermore aggregate earnings exhibits substantial persistence, suggesting current earnings convey information about future earnings. Finally we find that the earnings-returns relation at aggregate becomes less positive in countries with more transparent accounting disclosure. This result supports the argument proposed by Sadka and Sadka (2009) that predictability of aggregate earnings leads to the negative relation between aggregate earnings and market returns in the U.S..